Option pricing in an imperfect world

Gianluca Cassese

No 277, Working Papers from University of Milano-Bicocca, Department of Economics

Abstract: In a model with no given probability measure, we consider asset pricing in the presence of frictions and other imperfections and characterize the property of coherent pricing, a notion related to (but much weaker than) the no arbitrage property. We show that prices are coherent if and only if the set of pricing measures is non empty, i.e. if pricing by expectation is possible. We then obtain a decomposition of coherent prices highlighting the role of bubbles. Eventually we show that under very weak conditions the coherent pricing of options allows for a very clear representation from which it is possible, as in the original work of Breeden and Litzenberger, to extract the implied probability. Eventually we test this conclusion empirically via a new non parametric approach.

Keywords: Arbitrage; Bid/Ask spreads; Bubbles; Coherence; Risk-neutral probability; Transaction costs. (search for similar items in EconPapers)
JEL-codes: C14 G12 (search for similar items in EconPapers)
Pages: 52
Date: 2014-06, Revised 2014-06
New Economics Papers: this item is included in nep-cfn
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http://repec.dems.unimib.it/repec/pdf/mibwpaper277.pdf First version, 2014 (application/pdf)

Related works:
Working Paper: Option Pricing in an Imperfect World (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:mib:wpaper:277

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