Author: Lars E. O. SvenssonPublisher:
ISBN:
Category :
Languages : en
Pages : 46
Book Description
Nontraded Assets in Incomplete Markets
Author: Lars E. O. SvenssonPublisher:
ISBN:
Category : Investments
Languages : en
Pages : 25
Book Description
Nontraded Assets in Incomplete Markets
Author: Lars E. O. SvenssonStrategic Exercise of Options on Non-traded Assets and Stochastic Volatility in an Incomplete Market
Author: SingRu HoePublisher:
ISBN: 9780542722721
Category : Economics
Languages : en
Pages :
Book Description
The first study explores optimal investment policies for strategic option exercise when the underlying project is not traded. A duopoly model captures strategic interactions, while a partial spanning asset models market incompleteness. The option value to invest is obtained through indifference pricing, i.e., certainty equivalent value. I find that incompleteness narrows the gap between leader and follower entry dates. The follower enters much sooner, and the leader delays slightly compared to classic real options models. Modeling investment income stream as an Arithmetic Brownian motion is a better fit than Geometric Brownian motion, while reducing the necessary numerical approximations for obtaining the results in the incomplete market situation. As a byproduct of modeling two different stochastic income streams, I investigate the impact of market share and uncertainty on the relative investment trigger as well as the option value to invest. Results are sensitive to these factors; thus, it is important to model stochastic processes to accurately reflect the real world circumstances. The second study explores the valuation consequences of incompleteness resulting from stochastic volatility in a real options setting. The optimal policy is obtained through q-optimal measures as well as indifference pricing. I examine the efficacy of different approaches to finding and justifying a particular martingale measure. Stochastic volatility induced market incompleteness affects the investment/abandonment decision in several important ways. In addition, I demonstrate that indifference prices for the option value to invest and the abandonment option solve quasilinear variational inequalities with obstacle terms. With the exponential utility function, the utility-based indifference price admits a new pricing measure, which is the minimal relative entropy martingale measure minimizing the relative entropy between the historical measure and the Q martingale measure. I also show that the indifference price is non-increasing with respect to risk aversion. As the risk aversion parameter converges to zero, the indifference price converges to the unique bounded viscosity solution of the linear variational inequality with obstacle term.
Closed-Form Solutions for Options in Incomplete Markets
Author: Oana FloroiuPublisher:
ISBN:
Category :
Languages : en
Pages : 23
Book Description
This paper reconsiders the predictions of the standard option pricing models in the context of incomplete markets. We relax the completeness assumption of the Black-Scholes (1973) model and as an immediate consequence we can no longer construct a replicating portfolio to price the option. Instead, we use the good-deal bounds technique to arrive at closed-form solutions for the option price. We determine an upper and a lower bound for this price and find that, contrary to Black-Scholes (1973) options theory, increasing the volatility of the underlying asset does not necessarily increase the option value. In fact, the lower bound prices are always a decreasing function of the volatility of the underlying asset, which cannot be explained by a Black-Scholes (1973) type of argument. In contrast, this is consistent with the presence of unhedgeable risk in the incomplete market. Furthermore, in an incomplete market where the underlying asset of an option is either infrequently traded or non-traded, early exercise of an American call option becomes possible at the lower bound, because the economic agent wants to lock in value before it disappears as a result of increased unhedgeable risk.
Incomplete Markets with Endogenous Portfolio Constraints and Redundant Assets
Author: Guangsug HahnPublisher:
ISBN:
Category :
Languages : en
Pages : 20
Book Description
This paper shows that a competitive equilibrium exists in an exchange economy with incomplete financial markets where redundant assets are traded and the asset trading of each agent is subject to endogenous portfolio constraints. The set of budget-feasible portfolios need not be bounded in the presence of redundant assets. To address this problem, we impose the positive semi-independence condition on individual portfolio constraints.
Evaluating the Effects of Incomplete Markets on Risk Sharing Nad Asset Pricing
Author: John HeatonPricing and Hedging in Incomplete Markets with Model Uncertainty
Author: Anne BalterPublisher:
ISBN:
Category :
Languages : en
Pages : 31
Book Description
We search for a trading strategy and the associated robust price of unhedgeable assets in incomplete markets under the acknowledgement of model uncertainty. Our set-up is that we postulate an agent who wants to maximise the expected surplus by choosing an optimal investment strategy. Furthermore, we assume that the agent is concerned about model misspecification. This robust optimal control problem under model uncertainty leads to (i) risk-neutral pricing for the traded risky assets, and (ii) adjusting the drift of the nontraded risk drivers in a conservative direction. The direction depends on the agent's long or short position, and the adjustment that ensures a robust strategy leads to what is known as "actuarial" or "prudential" pricing. Our results extend to a multivariate setting. We prove existence and uniqueness of the robust price in an incomplete market via the link between the semilinear partial differential equation and backward stochastic differential equations.
Dynamic Asset Allocation in the Presence of Housing and Incomplete Markets
Author: Rune MølgaardPublisher:
ISBN:
Category :
Languages : en
Pages : 73
Book Description
This paper studies in continuous time and in an incomplete market setting the optimal housing, consumption, labor and portfolio choice of an agent in the presence of stochastic house prices and wages. Thus, the house prices and wage rates cannot be spanned by the financial market. In particular, the paper investigates the optimal strategies under two different preference specifications with respect to housing. The paper provides new closed-form solutions in the special case in which the market is complete. In addition, the paper also studies the optimal housing, consumption, labor, portfolio and welfare implications of frictions in the housing market. Particularly, the optimal strategies and welfare loss are analyzed if the house is a non-traded asset. This paper suggests that the consumption, labor, speculative investment and hedging of human capital is similar across preference specification and frictions in the market for housing when the economy is complete. The consumption and labor strategies are, however, dependent on frictions in the market for housing in the case where the economy is incomplete. The welfare loss from these frictions is small in magnitude but will influence the optimal consumption, labor and portfolio choice.
Controlled Markov Processes and Viscosity Solutions
Author: Wendell H. FlemingPublisher: Springer Science & Business Media
ISBN: 0387310711
Category : Mathematics
Languages : en
Pages : 436
Book Description
This book is an introduction to optimal stochastic control for continuous time Markov processes and the theory of viscosity solutions. It covers dynamic programming for deterministic optimal control problems, as well as to the corresponding theory of viscosity solutions. New chapters in this second edition introduce the role of stochastic optimal control in portfolio optimization and in pricing derivatives in incomplete markets and two-controller, zero-sum differential games.
Home Bias and High Turnover
Author: Viktoria V. HnatkovskaPublisher:
ISBN:
Category :
Languages : en
Pages : 36
Book Description
Why do investors trade a lot in foreign assets and hold so little of them in their portfolios? This paper shows that both observations can arise naturally in the presence of nondiversifiable nontraded consumption risk when each country specializes in production, preferences exhibit consumption home bias, and asset markets are incomplete. Using a general equilibrium two-country, two-sector (tradable and nontradable) model of the world economy with production I show that low diversification occurs because variations in relative prices (i) increase the riskiness of foreign assets and (ii) facilitate risk-sharing across countries. Large and volatile capital flows are necessary to take advantage of international risk premia differentials that occur in response to productivity changes in the nontradable sector. I characterize the optimal portfolio holdings, the evolution of the investment opportunity set, the risk premium, and the dynamics of capital flows using a new methodology for solving dynamic general equilibrium models with incomplete markets and portfolio choice.