Option valuation and hedging in markets with a crunch

2017 ◽  
Vol 44 (5) ◽  
pp. 801-815 ◽  
Author(s):  
Youssef El-Khatib ◽  
Abdulnasser Hatemi-J
Keyword(s):  
Financial Crisis ◽  
Option Pricing ◽  
Financial Risk ◽  
Asset Price ◽  
Hedging Strategy ◽  
Numerical Application ◽  
Content Type ◽  
Hedging Strategies ◽  
Option Pricing Model ◽  
Better Than

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.

A leader’s guide to strategic risk management

2015 ◽  
Vol 43 (1) ◽  
pp. 26-35 ◽  
Author(s):  
Joseph Calandro
Keyword(s):  
Risk Management ◽  
Financial Crisis ◽  
Financial Risk ◽  
Weak Signals ◽  
Content Type ◽  
Corporate Leaders ◽  
Strategic Risk ◽  
Hedging Strategies ◽  
Market Pressures ◽  
Strategic Risk Management

Purpose – Many firms did not have mechanisms in place prior to 2007 to identify and track the weak signals of an impending financial crisis, and as a result they were not prepared for the stresses and opportunities the crisis generated. The author aims to offer a guide to identifying these weak signals and a system for mitigating the risk of being hurt by another such crisis. Design/methodology/approach – This is a guide to strategic risk management (SRM), which defines a process of identifying, assessing and economically managing potentially enterprise-threatening losses. It is a way to mitigate developing ambiguous threats before they manifest themselves and then spiral out of control. Findings – Corporate leaders can follow the example of savvy investors who use risk management insights to mitigate the effects of a potential crisis and to profit from one if it develops. Practical implications – Market pressures can cause firms to loosen product or investment standards incrementally, which over time can radically change a business model’s risk profile without anyone acting to mitigate it. Originality/value – This guide to Strategic Risk Management provides insight into how corporate leaders can identify the “weak signals” of a financial crisis well before the actual crisis develops and also describes how they can mitigate financial risk in their portfolios and make opportunistic investments and adopt hedging strategies at very favorable price levels.

scholarly journals Good Volatility, Bad Volatility, and Option Pricing

2018 ◽  
Vol 54 (2) ◽  
pp. 695-727 ◽  
Author(s):  
Bruno Feunou ◽  
Cédric Okou
Keyword(s):  
Option Pricing ◽  
Stock Price ◽  
Asset Price ◽  
Jump Diffusion ◽  
Quadratic Variation ◽  
Pricing Model ◽  
Economic Gain ◽  
Underlying Asset ◽  
Model Free ◽  
Option Pricing Model

Advances in variance analysis permit the splitting of the total quadratic variation of a jump-diffusion process into upside and downside components. Recent studies establish that this decomposition enhances volatility predictions and highlight the upside/downside variance spread as a driver of the asymmetry in stock price distributions. To appraise the economic gain of this decomposition, we design a new and flexible option pricing model in which the underlying asset price exhibits distinct upside and downside semivariance dynamics driven by the model-free proxies of the variances. The new model outperforms common benchmarks, especially the alternative that splits the quadratic variation into diffusive and jump components.

A new method to solve fuzzy stochastic finance problem

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Jayanta Kumar Dash ◽  
Sumitra Panda ◽  
Golak Bihari Panda
Keyword(s):  
Option Pricing ◽  
Market Price ◽  
Pricing Model ◽  
Strike Price ◽  
Content Type ◽  
Fuzzy Environment ◽  
Black Scholes ◽  
Option Pricing Model ◽  
A New Technique ◽  
Log Normal

PurposeThe authors discuss the value of portfolio and Black–Scholes (B–S)-option pricing model in fuzzy environment.Design/methodology/approachThe B–S option pricing model (OPM) is an important role of an OPM in finance. Here, every decision is taken under uncertainty. Due to randomness or vagueness, these uncertainties may be random or fuzzy or both. As the drift µ, the degree of volatility s, interest rate r, strike price k and other parameters of the value of the portfolio V(t), market price S_0 (t) and call option C(t) are not known exactly, so they are treated as positive fuzzy number. Partial expectation of fuzzy log normal distribution is derived. Also the value of portfolio at any time t and the B–S OPM in fuzzy environment are derived. A numerical example of B–S OPM is illustrated.FindingsFirst, the authors are studying some various paper and some stochastic books.Originality/valueThis is a new technique.

scholarly journals Preemption of compliance costs and the voluntary adoption of SFAS No. 123(R)

2014 ◽  
Vol 12 (1) ◽  
pp. 2-20
Author(s):  
Ahmed Ebrahim ◽  
Bruce Bradford
Keyword(s):  
Option Pricing ◽  
Stock Price ◽  
Price Volatility ◽  
Stock Option ◽  
Pricing Model ◽  
Compliance Cost ◽  
Compliance Costs ◽  
Content Type ◽  
Option Pricing Model ◽  
Voluntary Adoption

Purpose – This paper aims to study a preemption proposition for the compliance costs associated with stock option expensing under SFAS 123(R) by examining whether early adopters used their discretion over option pricing model inputs to mitigate the adoption effect. Design/methodology/approach – The paper uses a matched sample approach of firms that voluntarily adopted stock option expensing during the 2002-2004 period and similar firms that waited until the mandatory expensing. The paper empirically examines some determinants of voluntary adoption, and the changes in option pricing model inputs during the period leading to mandatory expensing. Findings – The paper reports evidence that voluntary adopters of stock option expensing during the 2002-2004 period have used the period leading to mandatory expensing to preempt its compliance cost effect. The authors exercised their discretion by decreasing estimates for stock price volatility and time-to-maturity to preempt or minimize the reduction in earnings before mandatory adoption date. Originality/value – Results of this paper are useful to accounting regulators in understanding the reaction of financial statement preparers to deliberations, effective dates and voluntary early adoption terms of the accounting standards setting process.

Risk-sharing finance governance: Islamic vs conventional indexes option pricing

2018 ◽  
Vol 44 (5) ◽  
pp. 540-550
Author(s):  
Haykel Hamdi ◽  
Jihed Majdoub
Keyword(s):  
Option Pricing ◽  
Risk Sharing ◽  
Research Question ◽  
Option Price ◽  
Empirical Literature ◽  
Risk Governance ◽  
Hedging Strategy ◽  
Content Type ◽  
Dynamic Case ◽  
Conventional Counterpart

Purpose Risk governance has an important influence on the hedging performances in option pricing and portfolio hedging in both discrete and dynamic case for both conventional and Islamic indexes. The paper aims to discuss these issues. Design/methodology/approach This paper explores option pricing and portfolio hedging in a discrete and dynamic case with transaction costs. Monte Carlo simulations are applied to both conventional and Islamic indexes in US and UK markets. Simulations show that conventional and Islamic assets do not exhibit the same price and portfolio hedging strategy governance. Findings The authors conclude that Islamic assets show different option price and hedging strategy compared to their conventional counterpart. Originality/value The research question of this paper aims at filling the gap in the empirical literature by exploring option price and hedging structure for both conventional and Islamic indexes in US and UK stock markets.

Value of waiting – option pricing as a tool for residential real estate fund divestment management

2014 ◽  
Vol 32 (5) ◽  
pp. 400-414 ◽  
Author(s):  
Jussi Vimpari ◽  
Seppo Junnila
Keyword(s):  
Real Estate ◽  
Option Pricing ◽  
Investment Decision ◽  
Capital Investments ◽  
Residential Real Estate ◽  
Content Type ◽  
Industry Standard ◽  
Option Pricing Model ◽  
Embedded Case Study

Purpose – The value of waiting to invest has been acknowledged in management of real capital investments. Investment decision should be undertaken only if it can justify giving up the value of the option to wait; the same logic is proposed here to be applicable on divestment management of a real estate fund. The purpose of this paper is to test option pricing to quantify the option to wait in a residential real estate fund divestment. It is argued that standard industry valuation practices miss the value of active fund management that should be included when planning a fund divestment strategy. Design/methodology/approach – Dynamic programming, specifically binomial option-pricing model is suggested to complement the current industry standard valuation approaches. The approach is tested in an embedded case study where assets of a residential real estate fund are valuated using the model. Findings – Option pricing can provide risk-neutral quantified value whether an apartment building portfolio should be divested in a single transaction or in multiple transactions over time. In the case study, an option value of 6.6 per cent was found for a residential real estate portfolio. Originality/value – This study is the first of its kind to propose that value of waiting to divest is an important element when planning a real estate fund divestment. The approach proposed in this study risk-neutrally calculates the value appreciation from the range of the potential values. This provides the decision-maker a deeper understanding of the implications regarding the chosen line of action.

Research on Option Pricing Model under Uncertainty

2014 ◽  
Vol 513-517 ◽  
pp. 3156-3159
Author(s):  
Kun Long Zhang ◽  
Li Xia Song
Keyword(s):  
Empirical Study ◽  
Option Pricing ◽  
Financial Market ◽  
Price Change ◽  
Asset Price ◽  
Pricing Model ◽  
Pricing Models ◽  
Uncertain Environments ◽  
Option Pricing Model ◽  
Behavior Choice

In the real financial market, there are always other uncertain phenomena, such as fuzzy phenomenon, random phenomenon. Along with empirical study increasing investigator discovered that this kind of uncertainty affects policy-maker's behavior choice and the asset price change. Researcher pay more and more attention to the problems on the option pricing under in uncertain environments, Therefore, the paper shows that options can be valued successfully in uncertain environments, some option pricing models are established, the corresponding algorithm is designed to solve these models.

Valuing “Raise Your Rate” certificates of deposit

2014 ◽  
Vol 40 (9) ◽  
pp. 864-882
Author(s):  
Peter Brous ◽  
Bonnie G. Buchanan ◽  
Tony Orcutt
Keyword(s):  
Option Pricing ◽  
Pricing Model ◽  
Optimal Point ◽  
Strategic Investment ◽  
Content Type ◽  
Market Rate ◽  
Economic Climate ◽  
Investment Opportunities ◽  
Option Pricing Model ◽  
Alternative Investment

Purpose – The “raise your rate” (RYR) certificate of deposit (CD) allows investors to raise the rate on their CD to the current market rate over the life of the CD. The purpose of this paper is to present a binomial option pricing model to value this option to raise the rate. The model also demonstrates conditions under which the investor should choose to exercise their option and raise their rate prior to maturity. Understanding the value of this option is useful to both banks setting rates, and investors comparing alternative investment opportunities. The results of this model suggest that, for CDs with short maturities and low yields, the value of the option is relatively small, roughly one to four basis points, however, for CDs with longer maturities and higher yields the value of the option can be as much as 50-80 basis points. Design/methodology/approach – This paper demonstrates how to value raise your rate CDs by applying a binomial option pricing model and provides the value of this option over a range of current CD yields and over a range of CD maturities. Findings – When CD rates are low and maturities are short the value of the option is small (one to four basis points), however, when CD rates are high with longer maturities, the value of this option can be significant (50-80 basis points). Research limitations/implications – The research implication is that the rate discount that the institution offers and the investor accepts should reflect the value of the option to raise the rate. The benefit to the institution and the cost to the investor reflected in the rate discount can be determined by the procedures presented in this paper regarding the valuation of the option to raise the rate. Practical implications – The purpose of this paper is to demonstrate how to apply a binomial option pricing model to value the option that is attached to a raise your rate CD. Knowing the value of this option should be useful both to banks, in determining the discounted rate they should offer on these CDs, and to investors choosing among alternative investment opportunities. An additional benefit of applying a binomial model to value the option is that the model can be used by investors to determine the optimal point at which to exercise their option and lock in the current higher rate. Social implications – Given the recent financial turmoil, pressure has been placed on banks to increase their liquidity and deposit base. CDs are crucial to this. Understanding the value of the RYR option is useful to both banks setting rates and investors comparing alternative investment opportunities. Originality/value – Given the current economic climate, deciding which strategic investment options to pursue is of paramount importance. To the best of the knowledge this is the first study that applies binomial option pricing to certificates of deposit to help investors make these decisions.

scholarly journals The performance of Islamic banks during the 2008 global financial crisis

2019 ◽  
Vol 10 (3) ◽  
pp. 407-420 ◽  
Author(s):  
Mohammed Ebrahim Hussien ◽  
Md. Mahmudul Alam ◽  
Md. Wahid Murad ◽  
Abu N.M. Wahid
Keyword(s):  
Financial Crisis ◽  
Financial Risk ◽  
Global Financial Crisis ◽  
Structural Break ◽  
Capital Adequacy ◽  
Data Series ◽  
Islamic Banks ◽  
Content Type ◽  
Before And After ◽  
The Global Financial Crisis

Purpose The purpose of this study is to analyze the profitability performance of Islamic banks (IBs) of the Gulf Cooperation Council (GCC) region during 2008 global financial crisis. Design/methodology/approach Bank-specific data are taken from the Bank Scope database and macroeconomic data are collected from International Financial Statistics. Using a panel data series of 30 banks for the period of 2005 to 2011, the study shows the evidence of structural break for the crisis year as well as the factors that impact the profitability of IBs. Findings The performance of GCC IBs was significantly influenced during the crisis period by capital adequacy, credit risk, financial risk, operational efficiency, liquidity, bank size, gross domestic product, growth rate of money supply, bank sector development and inflation rate. The study also finds that there is a structural change before and after the global financial crisis. Originality/value This is an original study that shows that the Sharīʿah-compliant banks have performed better during the crisis and are not affected based on their internal performance records; rather, they have been affected indirectly from the macro shock owing to the overall economic crisis.

scholarly journals Lévy Process-Driven Asymmetric Heteroscedastic Option Pricing Model and Empirical Analysis

2018 ◽  
Vol 2018 ◽  
pp. 1-8
Author(s):  
Gaoxun Zhang ◽  
Yi Zheng ◽  
Honglei Zhang ◽  
Xinchen Xie
Keyword(s):  
Option Pricing ◽  
Lévy Process ◽  
Empirical Studies ◽  
Asset Price ◽  
Likelihood Estimation ◽  
Levy Process ◽  
Pricing Model ◽  
Financial Industry ◽  
Option Pricing Model ◽  
Asymmetric Garch

This paper describes the peak, fat tail, and skewness characteristics of asset price via a Lévy process. It applies asymmetric GARCH model to depict asset price’s random volatility characteristics and builds a GARCH-Lévy option pricing model with random jump characteristics. It also uses circular maximum likelihood estimation technology to improve the stability of model parameter estimation. In order to test the model’s pricing results, we use Hong Kong Hang Seng Index (HSI) price data and its option data to carry out empirical studies. Results prove that the pricing bias of EGARCH-Lévy model is lower than that of standard Heston-Nandi (HN) model in the financial industry. For short-term, middle-term, and long-term European-style options, the pricing error of EGARCH-Lévy model is the lowest.

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