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Bottleneck options

Author

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  • Curdin Ott

Abstract

In the spirit of Kyprianou and Ott (in Acta Appl. Math., to appear, 2013 ) and Ott (in Ann. Appl. Probab. 23:2327–2356, 2013 ) we consider an option whose payoff corresponds to a capped American lookback option with floating strike and solve the associated pricing problem (an optimal stopping problem) in a financial market whose price process is modelled by an exponential spectrally negative Lévy process. Despite the simple interpretation of the cap as a moderation of the payoff, it turns out that the optimal strategy to exercise the option looks very different compared to the situation without a cap. In fact, we show that the continuation region has a feature that resembles a bottleneck and hence the name “bottleneck option”. Copyright Springer-Verlag Berlin Heidelberg 2014

Suggested Citation

  • Curdin Ott, 2014. "Bottleneck options," Finance and Stochastics, Springer, vol. 18(4), pages 845-872, October.
    • Handle: RePEc:spr:finsto:v:18:y:2014:i:4:p:845-872
    DOI: 10.1007/s00780-013-0222-7
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    References listed on IDEAS

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    1. repec:bla:jfinan:v:58:y:2003:i:2:p:753-778 is not listed on IDEAS
    2. Peter Carr & Liuren Wu, 2003. "The Finite Moment Log Stable Process and Option Pricing," Journal of Finance, American Finance Association, vol. 58(2), pages 753-777, April.
    3. Conze, Antoine & Viswanathan, 1991. "Path Dependent Options: The Case of Lookback Options," Journal of Finance, American Finance Association, vol. 46(5), pages 1893-1907, December.
    4. L. Alili & A. E. Kyprianou, 2005. "Some remarks on first passage of Levy processes, the American put and pasting principles," Papers math/0508487, arXiv.org.
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    Cited by:

    1. Neofytos Rodosthenous & Mihail Zervos, 2017. "Watermark options," Finance and Stochastics, Springer, vol. 21(1), pages 157-186, January.

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    More about this item

    Keywords

    Bottleneck option; Optimal stopping; Principle of smooth and continuous fit; Lévy processes; Scale functions; 60G40; 60G51; 60J75; G13;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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