Alternatives to classical option pricing

W. Brent Lindquist () and Svetlozar T. Rachev
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W. Brent Lindquist: Texas Tech University
Svetlozar T. Rachev: Texas Tech University

Annals of Operations Research, 2025, vol. 346, issue 1, No 25, 489-509

Abstract: Abstract We develop two alternate approaches to arbitrage-free, market-complete, option pricing. The first approach requires no riskless asset. We develop the general framework for this approach and illustrate it with two specific examples. The second approach does use a riskless asset. However, by ensuring equality between real-world and risk-neutral price-change probabilities, the second approach enables the computation of risk-neutral option prices utilizing expectations under the natural world probability $${\mathbb{P}}$$ P . This produces the same option prices as the classical approach in which prices are computed under the risk neutral measure $${\mathbb{Q}}$$ Q . The second approach and the two specific examples of the first approach require the introduction of new, marketable asset types, specifically perpetual derivatives of a stock, and a stock whose cumulative return (rather than price) is deflated. These two asset types are designed specifically for hedgers who don’t have access to sovereign riskless rates or may be hesitant to utilize interbank rates such as SOFR.

Keywords: Option pricing; Financial markets without riskless asset; Shadow riskless rate; Perpetual derivative; Deflated cumulative return process (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s10479-024-06213-z

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