Scandinavian Working Papers in Economics
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Department of Economics, Lund University Working Papers, Department of Economics, Lund University

No 2007:10:
Option Pricing by Mathematical Programming

Sjur Flåm ()

Abstract: Financial options typically incorporate times of exercise. Alternatively, they embody set-up costs or indivisibilities. Such features lead to planning problems with integer decision variables. Provided the sample space be finite, it is shown here that integrality constraints can often be relaxed. In fact, simple mathematical programming, aimed at arbitrage or replication, may bound or identify option prices. When the asset market is incomplete, the bounds stem from nonlinear pricing functionals.

Keywords: asset pricing; arbitrage; options; finite sample space; scenario tree; equivalent martingale measures; bid-ask intervals; incomplete market; linear programming; combinatorial optimization; totally unimodular matrices.; (follow links to similar papers)

JEL-Codes: C61; G12; (follow links to similar papers)

20 pages, June 4, 2007

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