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Option Pricing in an Oligopolistic Setting

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  • Villena, Marcelo
  • Villena, Mauricio

Abstract

Option valuation models are usually based on frictionless markets. This paper extends and complements the literature by developing a model of option pricing in which the derivative and/or the underlying asset have an oligopolistic market structure, which produces an expected return on these assets that exceeds (or goes below) their fundamental value, and hence affects the option valuation. Our formulation begins modeling a capital asset pricing model that takes into account an oligopolistic setting, and hence the standard option pricing formula is derived, but this time considering the level of market power into the model. Our results show that higher levels of market power will lower the required expected return, in comparison to the perfectly competitive CAPM model. Similarly, simulations show that higher levels of market power in the derivative markets tend to increase the call option values in comparison to those values given by the standard Black and Scholes formulation, while the impact of market power in the underlying asset market tends to lower the option price.

Suggested Citation

  • Villena, Marcelo & Villena, Mauricio, 2011. "Option Pricing in an Oligopolistic Setting," MPRA Paper 57978, University Library of Munich, Germany, revised 16 Aug 2014.
    • Handle: RePEc:pra:mprapa:57978
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    File URL: https://mpra.ub.uni-muenchen.de/57978/1/MPRA_paper_57978.pdf
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    References listed on IDEAS

    as
    1. Acharya, Viral V. & Pedersen, Lasse Heje, 2005. "Asset pricing with liquidity risk," Journal of Financial Economics, Elsevier, vol. 77(2), pages 375-410, August.
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    3. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
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    5. John Lintner, 1965. "Security Prices, Risk, And Maximal Gains From Diversification," Journal of Finance, American Finance Association, vol. 20(4), pages 587-615, December.
    6. Husmann, Sven & Todorova, Neda, 2011. "CAPM option pricing," Finance Research Letters, Elsevier, vol. 8(4), pages 213-219.
    7. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    8. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Capital Asset Pricing; Option Pricing; Oligopolistic Markets.;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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