René Carmona, Princeton University
American Options with Multiple Exercises: Theory and Numerics.
Many financial transactions include multiple American exercise features:
we use examples from the energy markets as motivation. We review the
theory of optimal stopping in the classical case of a single stopping
opportunity, and we present some recent results when stopping opportunities
are multiple. We treat the geometric Brownian motion case in detail.We
then recast the problem in the framework of potential theory for Markov
processes, we use Rost's filling scheme to reformulate it as a linear
program, and we discuss numerical implementation issues. This approach
seems to be new, even in the case of standard American options.
Heath Windcliff, TD Securities
Pricing and Hedging in Incomplete Markets with Basis Risk
In this talk we extend the Black-Scholes framework to allow for the
pricing and hedging of option contracts when it is not possible to trade
directly in the underlying asset. For example, some popular insurance
products include guarantee features on mutual funds. If the insurer
is not able to short the underlying mutual fund, then hedging must be
performed by trading in an alternative, but similar, asset. Using simulation
we show that substantial errors can accumulate if one uses the Black-Scholes
model as a proxy for the appropriate pricing problem. As this is an
incomplete markets problem, it results in a non-linear PDE model that
includes a "market price of basis risk" and a bid-ask spread.
In simple (but common) cases, the non-linearity disappears and the pricing
problem can be solved analytically. In the general setting, there exist
robust numerical techniques that can be applied to the valuation of
complex derivative products in this setting.
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