Option Pricing with an Exponential Effect Function
14 Pages Posted: 17 Apr 2004
Date Written: March 24, 2004
Abstract
We consider option hedging and pricing for a large agent. The large agent affects the market's demand-supply equilibrium and, therefore, the market prices of financial instruments. By assuming a specific large agent's effect function for the underlying asset we derive the corresponding effect function for call options on that asset. As we show, the price of a call option in our model is the solution to a Black-Scholes partial differential equation with a modified terminal condition. Finally we estimate our model parameters from option market data and compare our model with other large agent models.
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