INDIFFERENCE PRICES AND IMPLIED VOLATILITIES

Matthew Lorig

Mathematical Finance, 2018, vol. 28, issue 1, 372-408

Abstract: We consider a general local†stochastic volatility model and an investor with exponential utility. For a European†style contingent claim, whose payoff may depend on either a traded or nontraded asset, we derive an explicit approximation for both the buyer's and seller's indifference prices. For European calls on a traded asset, we translate indifference prices into an explicit approximation of the buyer's and seller's implied volatility surfaces. For European claims on a nontraded asset, we establish rigorous error bounds for the indifference price approximation. Finally, we implement our indifference price and implied volatility approximations in two examples.

Date: 2018
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