Valuing Tradeability in Exponential Lévy Models
38 Pages Posted: 8 Nov 2019 Last revised: 24 Feb 2020
Date Written: November 6, 2019
The present article provides a novel theoretical way to evaluate tradeability in markets of ordinary exponential Lévy type. We consider non-tradeability as a particular type of market illiquidity and investigate its impact on the price of the assets. Starting from an adaption of the continuous-time optional asset replacement problem initiated by McDonald and Siegel (1986), we derive tradeability premiums and subsequently characterize them in terms of free-boundary problems. This provides a simple way to compute non-tradeability values, e.g. by means of standard numerical techniques, and, in particular, to express the price of a non-tradeable asset as a percentage of the price of a tradeable equivalent. Our approach is illustrated via numerical examples where we discuss various properties of the tradeability premiums.
Keywords: Tradeability, Liquidity, Exponential Lévy Processes, Real Options, Maturity Randomization, Optimal Stopping, Free-Boundary Problems
JEL Classification: C32, G12, G13
Suggested Citation: Suggested Citation