Option valuation and hedging in markets with a crunch

Research output: Contribution to journalArticlepeer-review

14 Citations (Scopus)

Abstract

Purpose: Option pricing is an integral part of modern financial risk management. The well-known Black and Scholes (1973) formula is commonly used for this purpose. The purpose of this paper is to extend their work to a situation in which the unconditional volatility of the original asset is increasing during a certain period of time. Design/methodology/approach: The authors consider a market suffering from a financial crisis. The authors provide the solution for the equation of the underlying asset price as well as finding the hedging strategy. In addition, a closed formula of the pricing problem is proved for a particular case. Furthermore, the underlying price sensitivities are derived. Findings: The suggested formulas are expected to make the valuation of options and the underlying hedging strategies during a financial crisis more precise. A numerical application is provided for determining the premium for a call and a put European option along with the underlying price sensitivities for each option. Originality/value: An alternative option pricing model is introduced that performs better than existing ones, especially during a financial crisis.

Original languageEnglish
Pages (from-to)801-815
Number of pages15
JournalJournal of Economic Studies
Volume44
Issue number5
DOIs
Publication statusPublished - 2017

Keywords

  • Black and Scholes formula
  • Financial crisis
  • Options pricing and hedging

ASJC Scopus subject areas

  • General Economics,Econometrics and Finance

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