American options in an imperfect market with default

Roxana Dumitrescu, Marie-Claire Quenez and Agn\`es Sulem

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Abstract: We study pricing and (super)hedging for American options in an imperfect market model with default, where the imperfections are taken into account via the nonlinearity of the wealth dynamics. The payoff is given by an RCLL adapted process $(\xi_t)$. We define the {\em seller's superhedging price} of the American option as the minimum of the initial capitals which allow the seller to build up a superhedging portfolio. We prove that this price coincides with the value function of an optimal stopping problem with nonlinear expectations induced by BSDEs with default jump, which corresponds to the solution of a reflected BSDE with lower barrier. Moreover, we show the existence of a superhedging portfolio strategy. We then consider the {\em buyer's superhedging price}, which is defined as the supremum of the initial wealths which allow the buyer to select an exercise time $\tau$ and a portfolio strategy $\varphi$ so that he/she is superhedged. Under the additional assumption of left upper semicontinuity along stopping times of $(\xi_t)$, we show the existence of a superhedge $(\tau, \varphi)$ for the buyer, as well as a characterization of the buyer's superhedging price via the solution of a nonlinear reflected BSDE with upper barrier.

Date: 2017-08
New Economics Papers: this item is included in nep-rmg
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