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Dynamic Spanning: Are Options an Appropriate Instrument?

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  • Bajeux, I.
  • Rochet, J.C.

Abstract

Ross (1976) has shown, in a static framework, how options can complete financial markets. This paper examines the possible extensions of Ross's idea in a dynamic setup. Surprisingly enough, we find that the answer is very sensitive to the choice of the stochastic model for the underlying security returns. More specifically we obtain the following results: In a discrete‐time model, classical European options typically become redundant with some probability (Proposition 2.1). Obnly path dependent (“exotic”) options may generate dynamic spanning (Proposition 4.1). In a continuous‐time model with stochastic volatility of the underlying security, and under reasonable assumptions, a European option is always a good instrument for completing markets (Proposition 5.2).
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Suggested Citation

  • Bajeux, I. & Rochet, J.C., 1994. "Dynamic Spanning: Are Options an Appropriate Instrument?," Papers 94.329, Toulouse - GREMAQ.
    • Handle: RePEc:fth:gremaq:94.329
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    Cited by:

    1. Mele, Antonio, 2004. "General properties of rational stock-market fluctuations," LSE Research Online Documents on Economics 24701, London School of Economics and Political Science, LSE Library.
    2. Alexandre M. Baptista, 2005. "Options And Efficiency In Multidate Security Markets," Mathematical Finance, Wiley Blackwell, vol. 15(4), pages 569-587, October.
    3. Alexandre Baptista, 2000. "Options and Efficiency in Multiperiod Security Markets," Econometric Society World Congress 2000 Contributed Papers 0299, Econometric Society.
    4. Fornari, Fabio & Mele, Antonio, 2001. "Recovering the probability density function of asset prices using garch as diffusion approximations," Journal of Empirical Finance, Elsevier, vol. 8(1), pages 83-110, March.
    5. C. Mancini, 2002. "The European options hedge perfectly in a Poisson-Gaussian stock market model," Applied Mathematical Finance, Taylor & Francis Journals, vol. 9(2), pages 87-102.
    6. Antonio Mele, 2003. "Fundamental Properties of Bond Prices in Models of the Short-Term Rate," The Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 679-716, July.
    7. E. Jouini & P. -F. Koehl & N. Touzi, 1997. "Incomplete markets, transaction costs and liquidity effects," The European Journal of Finance, Taylor & Francis Journals, vol. 3(4), pages 325-347.
    8. Alziary, Benedicte & Decamps, Jean-Paul & Koehl, Pierre-Francois, 1997. "A P.D.E. approach to Asian options: analytical and numerical evidence," Journal of Banking & Finance, Elsevier, vol. 21(5), pages 613-640, May.
    9. Alziary Chassat, Bénédicte & Takac, Peter, 2017. "On the Heston Model with Stochastic Volatility: Analytic Solutions and Complete Markets," TSE Working Papers 17-796, Toulouse School of Economics (TSE).
    10. Jovanovic, Franck & Schinckus, Christophe, 2017. "Econophysics and Financial Economics: An Emerging Dialogue," OUP Catalogue, Oxford University Press, number 9780190205034.

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    Keywords

    financial market;

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