Kelly Trading and Option Pricing

Hans-Peter Bermin and Magnus Holm
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Hans-Peter Bermin: Knut Wicksell Centre for Financial Studies, Lund University
Magnus Holm: Hilbert Capital

No 2019/3, Knut Wicksell Working Paper Series from Lund University, Knut Wicksell Centre for Financial Studies

Abstract: In this paper we show that a Kelly trader is indifferent to trade the derivative if and only if the no-arbitrage price is uniquely given by the minimal martingale measure no-arbitrage price, thus providing a natural selection mechanism for option pricing in incomplete markets. We also show that the unique Kelly indifference price results in market equilibrium, in the sense that no Kelly trader can improve the magnitude of his instantaneous Sharpe ratio, by trading the derivative, given the actions of the other market participants.

Keywords: Option pricing; Incomplete markets; Hansen-Jagannathan bound; Minimal martingale measure; Kelly Indifference price; Kelly Equilibrium (search for similar items in EconPapers)
JEL-codes: G20 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2019-12-17
New Economics Papers: this item is included in nep-cfn and nep-ore
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