Stochastically fair price for financial options in incomplete markets

Rustem Sadykov () and Dongming Wei ()
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Rustem Sadykov: Nazarbayev University [Kazakhstan]
Dongming Wei: Nazarbayev University [Kazakhstan]

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Abstract: In the framework of tree methods for financial options pricing, we propose to use a new notion of stochastically fair price within the fair price range for financial options in incomplete markets. This subset of fair prices is efficient in a sense that it excludes not only arbitrage, but also stochastic arbitrage based on the concept of stochastic dominance. We define stochastically fair prices and present a methodology to compute them for options by using the stochastic optimisation techniques with stochastic constraints involving doubly stochastic matrices. We use a simple trinomial model for illustration.

Keywords: stochastic dominance arbitrage stochastic arbitrage option pricing portfolio optimization stochastically fair price doubly stochastic matrices; stochastic dominance; arbitrage; stochastic arbitrage; option pricing; portfolio optimization; stochastically fair price; doubly stochastic matrices (search for similar items in EconPapers)
Date: 2024-09-02
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