OPTIMAL INVESTMENT AND CONTINGENT CLAIM VALUATION WITH EXPONENTIAL DISUTILITY UNDER PROPORTIONAL TRANSACTION COSTS

Alet Roux and Zhikang Xu ()
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Alet Roux: Department of Mathematics, University of York, Heslington YO10 5DD, UK
Zhikang Xu: Barclays, 1 Churchill Place, London, E14 5HP, UK

International Journal of Theoretical and Applied Finance (IJTAF), 2022, vol. 25, issue 04n05, 1-45

Abstract: We consider indifference pricing of contingent claims consisting of payment flows in a discrete-time model with proportional transaction costs and under exponential disutility. This setting covers utility maximization of terminal wealth as a special case. A dual representation is obtained for the associated disutility minimization problem, together with a dynamic procedure for solving it. This leads to efficient and convergent numerical procedures for indifference pricing, optimal trading strategies and shadow prices that apply to a wide range of payoffs, a large range of time steps and all magnitudes of transaction costs.

Keywords: Transaction costs; option pricing; utility maximization; entropy; indifference pricing; generalized convex hull; dynamic programming (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1142/S0219024922500170

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