UNCERTAINTY IN PRICING TRADABLE OPTIONS

Jorge R. Sobehart () and Sean C. Keenan ()
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Jorge R. Sobehart: Citigroup Risk Architecture, 388 Greenwich, NY 10013, USA
Sean C. Keenan: Citigroup Risk Architecture, 388 Greenwich, NY 10013, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2003, vol. 06, issue 02, 103-117

Abstract: In this paper we introduce an options pricing model consistent with the level of uncertainty observed in the options market. By assuming that the price at which an option can be traded is intrinsically uncertain, either because of the inability to hedge continuously or because of errors in the estimation of the security's volatility and interest rates, random delays in the execution of orders or information deficiencies, we show that the Black-Scholes model produces a biased estimate of the expected value of tradable options. Information deficiencies lead to a call-put relationship that reduces to the standard call-put expression on average but shows random fluctuations consistent with the concept of market equilibrium. The same information deficiencies can contribute to the volatility skew that affects the Black-Scholes model.

Keywords: Option pricing; uncertainty; arbitrage (search for similar items in EconPapers)
Date: 2003
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DOI: 10.1142/S0219024903001864

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