Working Papers, Department of Economics, Lund University
Option Pricing by Mathematical Programming
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
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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