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Leland's approach to option pricing. The evolution of a discontinuity.

Grandits, Peter and Schachinger, Werner (1999) Leland's approach to option pricing. The evolution of a discontinuity. Report Series SFB "Adaptive Information Systems and Modelling in Economics and Management Science", 26. SFB Adaptive Information Systems and Modelling in Economics and Management Science, WU Vienna University of Economics and Business, Vienna.

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Abstract

A claim of Leland (1985) states that in the presence of transaction costs a call option on a stock S, described by geometric Brownian motion, can be perfectly hedged using Black-Scholes delta hedging with a modified volatility. Recently Kabanov and Safarian (1997) disproved this claim, giving an explicit (up to an integral) expression of the limiting hedging error, which appears to be strictly negative and depends on the path of the stock price only via the stock price at expiry ST . We prove in this paper that the limiting hedging error, considered as a function of ST, exhibits a removable discontinuity at the exercise price. Furthermore, we provide a quantitative result describing the evolution of the discontinuity, which shows that its precursors can very well be observed also in cases of reasonable length of revision intervals. (author's abstract)

Item Type: Paper
Keywords: transaction costs / hedging
Divisions: Departments > Informationsverarbeitung u Prozessmanag. > Produktionsmanagement > Taudes
Departments > Finance, Accounting and Statistics > Statistics and Mathematics
Departments > Marketing > Service Marketing und Tourismus
Departments > Informationsverarbeitung u Prozessmanag. > Informationswirtschaft
Depositing User: Repository Administrator
Date Deposited: 08 Mar 2002 09:25
Last Modified: 27 Jan 2015 20:19
URI: http://epub.wu.ac.at/id/eprint/1448

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