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Super-replicating Bounds on European Option Prices when the Underlying Asset is Illiquid

Author

Listed:
  • João Amaro de Matos

    (School of Economics, Universidade Nova de Lisboa)

  • Paula Antão

    (School of Economics, Universidade Nova de Lisboa)

Abstract

We derive super-replicating bounds on European option prices when the underlying asset is illiquid. Illiquidity is taken as the impossibility of transacting the underlying asset at some points in time, generating market incompleteness. We conclude that option price bounds follow a Black-Scholes partial differential equation where the volatility term is adjusted to reflect different levels of illiquidity.

Suggested Citation

  • João Amaro de Matos & Paula Antão, 2001. "Super-replicating Bounds on European Option Prices when the Underlying Asset is Illiquid," Economics Bulletin, AccessEcon, vol. 7(1), pages 1-7.
    • Handle: RePEc:ebl:ecbull:eb-01g10003
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    References listed on IDEAS

    as
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    4. Rüdiger Frey & Carlos A. Sin, 1999. "Bounds on European Option Prices under Stochastic Volatility," Mathematical Finance, Wiley Blackwell, vol. 9(2), pages 97-116, April.
    5. Boyle, Phelim P & Vorst, Ton, 1992. "Option Replication in Discrete Time with Transaction Costs," Journal of Finance, American Finance Association, vol. 47(1), pages 271-293, March.
    6. Engle, Robert F, 1999. "Modeling the Impacts of Market Activity on Bid-Ask Spreads in the Option Market," University of California at San Diego, Economics Working Paper Series qt6rp7g17q, Department of Economics, UC San Diego.
    7. (*), Thaleia Zariphopoulou & George M. Constantinides, 1999. "Bounds on prices of contingent claims in an intertemporal economy with proportional transaction costs and general preferences," Finance and Stochastics, Springer, vol. 3(3), pages 345-369.
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    9. Longstaff, Francis A, 2001. "Optimal Portfolio Choice and the Valuation of Illiquid Securities," The Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 407-431.
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    Cited by:

    1. Joao Amaro de Matos & Ana Lacerda, 2004. "Dry markets and superreplication bounds of American derivatives," Nova SBE Working Paper Series wp461, Universidade Nova de Lisboa, Nova School of Business and Economics.

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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G0 - Financial Economics - - General

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