A Note on the Suboptimality of Path-Dependent Pay-Offs in Levy Markets

Steven Vanduffel (), Andrew Chernih, Matheusz Maj and Wim Schoutens

Applied Mathematical Finance, 2009, vol. 16, issue 4, 315-330

Abstract: Cox and Leland used techniques from the field of stochastic control theory to show that, in the particular case of a Brownian motion for the asset log-returns, risk-averse decision makers with a fixed investment horizon prefer path-independent pay-offs over path-dependent pay-offs. In this note we provide a novel and simple proof for the Cox and Leland result and we will extend it to general Levy markets where pricing is based on the Esscher transform (exponential tilting). It is also shown that, in these markets, optimal path-independent pay-offs are increasing with the underlying final asset value. We provide examples that allow explicit verification of our theoretical findings and also show that the inefficiency cost of path-dependent pay-offs can be significant. Our results indicate that path-dependent investment pay-offs, the use of which is widespread in financial markets, do not offer good value from the investor's point of view.

Keywords: Path-dependent pay-offs; Levy markets (search for similar items in EconPapers)
Date: 2009
References: View complete reference list from CitEc
Citations: View citations in EconPapers (6)

Downloads: (external link)
http://www.tandfonline.com/doi/abs/10.1080/13504860802639360 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:apmtfi:v:16:y:2009:i:4:p:315-330

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/RAMF20

DOI: 10.1080/13504860802639360

Access Statistics for this article

Applied Mathematical Finance is currently edited by Professor Ben Hambly and Christoph Reisinger

More articles in Applied Mathematical Finance from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().