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Option valuation and hedging in markets with a crunch

Author

Listed:
  • Youssef El-Khatib
  • Abdulnasser Hatemi-J

Abstract

Purpose - Option pricing is an integral part of modern financial risk management. The well-known Black and Scholes (1973) formula is commonly used for this purpose. The purpose of this paper is to extend their work to a situation in which the unconditional volatility of the original asset is increasing during a certain period of time. Design/methodology/approach - The authors consider a market suffering from a financial crisis. The authors provide the solution for the equation of the underlying asset price as well as finding the hedging strategy. In addition, a closed formula of the pricing problem is proved for a particular case. Furthermore, the underlying price sensitivities are derived. Findings - The suggested formulas are expected to make the valuation of options and the underlying hedging strategies during a financial crisis more precise. A numerical application is provided for determining the premium for a call and a put European option along with the underlying price sensitivities for each option. Originality/value - An alternative option pricing model is introduced that performs better than existing ones, especially during a financial crisis.

Suggested Citation

  • Youssef El-Khatib & Abdulnasser Hatemi-J, 2017. "Option valuation and hedging in markets with a crunch," Journal of Economic Studies, Emerald Group Publishing Limited, vol. 44(5), pages 801-815, October.
    • Handle: RePEc:eme:jespps:jes-04-2016-0083
    DOI: 10.1108/JES-04-2016-0083
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    Cited by:

    1. Youssef El-Khatib & Abdulnasser Hatemi-J, 2023. "On a regime switching illiquid high volatile prediction model for cryptocurrencies," Journal of Economic Studies, Emerald Group Publishing Limited, vol. 51(2), pages 485-498, July.

    More about this item

    Keywords

    Financial crisis; Black and Scholes formula; Options pricing and hedging; C06; G01; G11; G12; G13;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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