A Closed-form Pricing Solution for Options on Assets with Pricing Errors

77 Pages Posted: 15 Jun 2021 Last revised: 28 Jul 2022

See all articles by Louis R. Piccotti

Louis R. Piccotti

Oklahoma State University - Stillwater - Spears School of Business

Date Written: July 27, 2022

Abstract

This paper examines the effects that pricing errors in the underlying asset have on options prices, their Greeks, and their implied risk neutral densities. Pricing errors can be viewed as a random proportional transaction cost. When pricing errors are information-unrelated, options prices are unambiguously higher than the Black-Scholes case and increasing in the pricing error variance. Hedging volatility is higher and the optimal exercise price for American put options is decreased. The option implied risk-neutral density and option Greeks are materially affected, which leads to suboptimal risk management and hedging when pricing errors are not accounted for.

Keywords: Pricing errors, options prices, mathematical finance

JEL Classification: G13

Suggested Citation

Piccotti, Louis R., A Closed-form Pricing Solution for Options on Assets with Pricing Errors (July 27, 2022). Available at SSRN: https://ssrn.com/abstract=3866267 or http://dx.doi.org/10.2139/ssrn.3866267

Louis R. Piccotti (Contact Author)

Oklahoma State University - Stillwater - Spears School of Business ( email )

460 Business
Stillwater, OK 74078-0555
United States

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