Discrete-Time Option Pricing with Stochastic Liquidity

Markus Leippold () and Steven Schaerer
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Steven Schaerer: University of Zurich, Students

No 16-15, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: Classical option pricing theories are usually built on the law of one price, neglecting the impact of market liquidity that may contribute to signi ficant bid-ask spreads. Within the framework of conic finance, we develop a stochastic liquidity model, extending the discrete-time constant liquidity model of Madan (2010). With this extension, we can replicate the term and skew structures of bid-ask spreads typically observed in option markets. We show how to implement such a stochastic liquidity model within our framework using multidimensional binomial trees and we calibrate it to call and put options on the S&P 500.

Keywords: Market Liquidity; Bid-Ask Spreads; Option Pricing; Stochastic Liquidity; Conic Finance (search for similar items in EconPapers)
JEL-codes: C51 D52 G12 G13 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2016-03
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Related works:
Journal Article: Discrete-time option pricing with stochastic liquidity (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1615

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