Pricing dynamic binary variables and their derivatives

David G. Luenberger

Quantitative Finance, 2012, vol. 12, issue 3, 451-464

Abstract: Many important assets or business ventures have cash flows that are not derivatives of a market security but are nevertheless dependent on some variable that is correlated with market prices. This includes many real option projects. This paper presents a methodology using a binary framework for pricing such assets by projection onto the market space. Under certain conditions, the result has the property that, given this price process, no risk-averse investor would choose to invest in this asset either long or short.

Date: 2012
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DOI: 10.1080/14697688.2011.584893

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