Bounds for path-dependent options

Donald Brown (), Rustam Ibragimov () and Johan Walden ()

Annals of Finance, 2015, vol. 11, issue 3, 433-451

Abstract: We develop new semiparametric bounds on the expected payoffs and prices of European call options and a wide range of path-dependent contingent claims. We first focus on the trinomial financial market model in which, as is well-known, an exact calculation of derivative prices based on no-arbitrage arguments is impossible. We show that the expected payoff of a European call option in the trinomial model with martingale-difference log-returns is bounded from above by the expected payoff of a call option written on an asset with i.i.d. symmetric two-valued log-returns. We further show that the expected payoff of a European call option in the multiperiod trinomial option pricing model is bounded by the expected payoff of a call option in the two-period model with a log-normal asset price. We also obtain bounds on the possible prices of call options in the (incomplete) trinomial model in terms of the parameters of the asset’s distribution. Similar bounds also hold for many other contingent claims in the trinomial option pricing model, including those with an arbitrary convex increasing payoff function as well as for path-dependent ones such as Asian options. We further obtain a wide range of new semiparametric moment bounds on the expected payoffs and prices of path-dependent Asian options with an arbitrary distribution of the underlying asset’s price. These results are based on recently obtained sharp moment inequalities for sums of multilinear forms and U-statistics and provide their first financial and economic applications in the literature. Similar bounds also hold for many other path-dependent contingent claims. Copyright Springer-Verlag Berlin Heidelberg 2015

Keywords: Option bounds; Trinomial model; Binomial model; Semiparametric bounds; Option prices; Expected payoffs; Path-dependent contingent claims; Asian options; Moment inequalities; G12; C02; C65 (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1007/s10436-015-0265-1

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