Neuberger, Anthony (2009) Bounds and robust hedging of the American option. Working Paper. Warwick Business School, Coventry.

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Abstract

The value of an American option depends on the information that the holder will acquire over the option’s life. Much of the literature makes restrictive assumptions about information revelation – for example that the underlying price process is Markov. With a richer information structure, the American feature becomes more valuable. This paper identifies the least upper bound on the price of an American option, placing no assumptions on the information structure. It shows that the American premium in standard models is a small fraction of its upper bound, and shows what features make the American feature most valuable. The bounds can be tightened by excluding implausible processes, and these bounds are enforced by a hedging strategy that is robust to model error.

Item Type:	Working or Discussion Paper (Working Paper)
Subjects:	H Social Sciences > HB Economic Theory Q Science > QA Mathematics
Divisions:	Faculty of Social Sciences > Warwick Business School > Financial Econometrics Research Centre Faculty of Social Sciences > Warwick Business School > Finance Group Faculty of Social Sciences > Warwick Business School
Library of Congress Subject Headings (LCSH):	Options (Finance) -- United States, Functions of bounded variation, Markov processes, Options (Finance) -- Mathematical models
Publisher:	Warwick Business School
Place of Publication:	Coventry
Date:	August 2009
Number of Pages:	40
Status:	Not Peer Reviewed
Access rights to Published version:	Open Access
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URI:	http://wrap.warwick.ac.uk/id/eprint/2936

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