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American options in an imperfect market with default

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  • Roxana Dumitrescu
  • Marie-Claire Quenez
  • Agn`es Sulem

Abstract

We study pricing and (super)hedging for American options in an imperfect market model with default, where the imperfections are taken into account via the nonlinearity of the wealth dynamics. The payoff is given by an RCLL adapted process $(\xi_t)$. We define the {\em seller's superhedging price} of the American option as the minimum of the initial capitals which allow the seller to build up a superhedging portfolio. We prove that this price coincides with the value function of an optimal stopping problem with nonlinear expectations induced by BSDEs with default jump, which corresponds to the solution of a reflected BSDE with lower barrier. Moreover, we show the existence of a superhedging portfolio strategy. We then consider the {\em buyer's superhedging price}, which is defined as the supremum of the initial wealths which allow the buyer to select an exercise time $\tau$ and a portfolio strategy $\varphi$ so that he/she is superhedged. Under the additional assumption of left upper semicontinuity along stopping times of $(\xi_t)$, we show the existence of a superhedge $(\tau, \varphi)$ for the buyer, as well as a characterization of the buyer's superhedging price via the solution of a nonlinear reflected BSDE with upper barrier.

Suggested Citation

  • Roxana Dumitrescu & Marie-Claire Quenez & Agn`es Sulem, 2017. "American options in an imperfect market with default," Papers 1708.08675, arXiv.org.
  • Handle: RePEc:arx:papers:1708.08675
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    References listed on IDEAS

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    1. Roxana Dumitrescu & Marie-Claire Quenez & Agnès Sulem, 2015. "Optimal Stopping for Dynamic Risk Measures with Jumps and Obstacle Problems," Journal of Optimization Theory and Applications, Springer, vol. 167(1), pages 219-242, October.
    2. Peter Bank & Dmitry Kramkov, 2015. "A model for a large investor trading at market indifference prices. I: Single-period case," Finance and Stochastics, Springer, vol. 19(2), pages 449-472, April.
    3. Peter Bank & Dmitry Kramkov, 2011. "A model for a large investor trading at market indifference prices. II: Continuous-time case," Papers 1110.3229, arXiv.org, revised Sep 2015.
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