Dry Markets and Superreplication Bounds of American Derivatives

FEUNL Working Paper No. 461

62 Pages Posted: 16 Feb 2006

See all articles by Joao Amaro de Matos

Joao Amaro de Matos

Nova School of Business and Economics

Ana Lacerda

New University of Lisbon - Faculdade de Economia

Date Written: November 15, 2005

Abstract

This paper studies the impact of dry markets for underlying assets on the pricing of American derivatives, using a disrete time framework. Dry markets are characterized by the possibility of non-existence of trading at certain dates. Such non-existence may be deterministic or probabilistic. Using superreplicating strategies, we derive expectation representations for the range of arbitrage-free values of the dervatives. In the probabilistic case, if we consider an enlarged filtration induced by the price process and the market existence process, ordinary stopping times are required. If not, randomized stopping times are required.Several comparisons of the ranges obtained with the two market restrictions are performed. Finally, we conclude that arbitrage arguments are not enough to define the optimal exercise policy.

Keywords: American derivatives, pricing, incomplete markets, dry markets, superreplication, randomized stopping times, strong duality

Suggested Citation

Amaro de Matos, Joao and Lacerda, Ana, Dry Markets and Superreplication Bounds of American Derivatives (November 15, 2005). FEUNL Working Paper No. 461. Available at SSRN: https://ssrn.com/abstract=882456 or http://dx.doi.org/10.2139/ssrn.882456

Joao Amaro de Matos (Contact Author)

Nova School of Business and Economics ( email )

Campus de Campolide
Lisbon, 1099-038
Portugal

HOME PAGE: http://docentes.fe.unl.pt/~amatos

Ana Lacerda

New University of Lisbon - Faculdade de Economia ( email )

Campus de Campolide
Lisboa, 1099-032
Portugal

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