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Bayesian Pricing of the Optimal-Replication Strategy for European Option in the JD(M)J Model

Author

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  • Maciej Kostrzewski

    (Cracow University of Economics
    University of Science and Technology)

Abstract

In incomplete markets replication strategies may not exist and pricing of derivatives is not an easy task. This paper presents an application of Bertsimas, Kogan and Lo’s algorithm of determining an optimal-replication strategy. In the Merton model the likelihood function is a product of a mixture of infinite number of components. In the paper this number is assumed to be equal to a fixed value M+1. To determine the optimal strategy, we should estimate unknown parameters. To this end we resort to Bayesian estimation techniques. The presented methodology is exemplified by an empirical research.

Suggested Citation

  • Maciej Kostrzewski, 2012. "Bayesian Pricing of the Optimal-Replication Strategy for European Option in the JD(M)J Model," Dynamic Econometric Models, Uniwersytet Mikolaja Kopernika, vol. 12, pages 53-72.
    • Handle: RePEc:cpn:umkdem:v:12:y:2012:p:53-72
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    References listed on IDEAS

    as
    1. Ole E. Barndorff-Nielsen & Neil Shephard, 2006. "Econometrics of Testing for Jumps in Financial Economics Using Bipower Variation," Journal of Financial Econometrics, Oxford University Press, vol. 4(1), pages 1-30.
    2. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    Cited by:

    1. Maciej Kostrzewski, 2015. "Bayesian DEJD Model and Detection of Asymmetry in Jump Sizes," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 7(1), pages 43-70, March.

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