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Option Pricing Bounds and the Elasticity of the Pricing Kernel

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  • James Huang

Abstract

In this paper we use power functions as pricing kernels to derive option-pricing bounds. We derive option pricing bounds given the bounds of the elasticity of the true pricing kernel. The bounds of the elasticity of the true pricing kernel are closely related to the bounds of the representative investor's coefficient of relative risk aversion. This methodology produces a tighter upper call option bound than traditional approaches. As a special case we show how to use the Black--Scholes formula to obtain option pricing bounds under the assumption of lognormality.

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  • James Huang, 2004. "Option Pricing Bounds and the Elasticity of the Pricing Kernel," Review of Derivatives Research, Springer, vol. 7(1), pages 25-51.
    • Handle: RePEc:kap:revdev:v:7:y:2004:i:1:p:25-51
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    Cited by:

    1. Hsuan-Chu Lin & Ren-Raw Chen & Oded Palmon, 2012. "Non-parametric method for European option bounds," Review of Quantitative Finance and Accounting, Springer, vol. 38(1), pages 109-129, January.
    2. Unyong Pyo, 2011. "Minimax price bounds in incomplete markets," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 35(3), pages 274-295, July.
    3. John Handley, 2005. "On the Upper Bound of a Call Option," Review of Derivatives Research, Springer, vol. 8(2), pages 85-95, August.

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