Option pricing in an investment risk-return setting

Stoyan V. Stoyanov, Svetlozar T. Rachev, Abootaleb Shirvani, Frank J. Fabozzi

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

In this paper, we combine modern portfolio theory and option pricing theory so that a trader taking a position in a European option contract, the underlying assets, and a risk-free bond can construct an optimal portfolio while ensuring that the option is perfectly hedged at maturity. We derive both the optimal holdings in the underlying assets for the trader’s optimal mean-variance portfolio and the amount of unhedged risk prior to maturity. Solutions assuming the price dynamics in the underlying assets follow a discrete binomial model, and continuous diffusions, stochastic volatility, volatility-of-volatility, and Merton’s jump-diffusion model are derived.

Original languageEnglish
Pages (from-to)1625-1638
Number of pages14
JournalApplied Economics
Volume54
Issue number14
DOIs
StatePublished - 2022

Keywords

  • binomial pricing trees
  • mean-variance portfolio
  • Merton jump diffusions
  • Option pricing
  • stochastic continuous diffusions
  • stochastic volatility
  • volatility-of-volatility

Fingerprint

Dive into the research topics of 'Option pricing in an investment risk-return setting'. Together they form a unique fingerprint.

Cite this