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An example of indifference prices under exponential preferences

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  • Marek Musiela
  • Thaleia Zariphopoulou

Abstract

The aim herein is to analyze utility-based prices and hedging strategies. The analysis is based on an explicitly solved example of a European claim written on a nontraded asset, in a model where risk preferences are exponential, and the traded and nontraded asset are diffusion processes with, respectively, lognormal and arbitrary dynamics. Our results show that a nonlinear pricing rule emerges with certainty equivalent characteristics, yielding the price as a nonlinear expectation of the derivative’s payoff under the appropriate pricing measure. The latter is a martingale measure that minimizes its relative to the historical measure entropy. Copyright Springer-Verlag Berlin/Heidelberg 2004

Suggested Citation

  • Marek Musiela & Thaleia Zariphopoulou, 2004. "An example of indifference prices under exponential preferences," Finance and Stochastics, Springer, vol. 8(2), pages 229-239, May.
    • Handle: RePEc:spr:finsto:v:8:y:2004:i:2:p:229-239
    DOI: 10.1007/s00780-003-0112-5
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