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Portfolios of American options under general preferences : results and counterexamples
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Henderson, Vicky, Sun, Jia and Whalley, A. Elizabeth (2014) Portfolios of American options under general preferences : results and counterexamples. Mathematical Finance, Volume 24 (Number 3). pp. 533-566. doi:10.1111/mafi.12008 ISSN 0960-1627.
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Official URL: http://dx.doi.org/10.1111/mafi.12008
Abstract
We consider the optimal exercise of a portfolio of American call options in an incomplete market. Options are written on a single underlying asset but may have different characteristics of strikes, maturities, and vesting dates. Our motivation is to model the decision faced by an employee who is granted options periodically on the stock of her company, and who is not permitted to trade this stock. The first part of our study considers the optimal exercise of single options. We prove results under minimal assumptions and give several counterexamples where these assumptions fail—describing the shape and nesting properties of the exercise regions. The second part of the study considers portfolios of options with differing characteristics. The main result is that options with comonotonic strike, maturity, and vesting date should be exercised in order of increasing strike. It is true under weak assumptions on preferences and requires no assumptions on prices. Potentially the exercise ordering result can significantly reduce the complexity of computations in a particular example. This is illustrated by solving the resulting dynamic programming problem in a constant absolute risk aversion utility indifference model.
| Item Type: | Journal Article | ||||||||||
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| Divisions: | Faculty of Social Sciences > Warwick Business School | ||||||||||
| Journal or Publication Title: | Mathematical Finance | ||||||||||
| Publisher: | Wiley-Blackwell Publishing, Inc. | ||||||||||
| ISSN: | 0960-1627 | ||||||||||
| Official Date: | July 2014 | ||||||||||
| Dates: |
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| Volume: | Volume 24 | ||||||||||
| Number: | Number 3 | ||||||||||
| Page Range: | pp. 533-566 | ||||||||||
| DOI: | 10.1111/mafi.12008 | ||||||||||
| Status: | Peer Reviewed | ||||||||||
| Publication Status: | Published | ||||||||||
| Access rights to Published version: | Restricted or Subscription Access |
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