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Derivative pricing based on local utility maximization

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Abstract.

This paper discusses a new approach to contingent claim valuation in general incomplete market models. We determine the neutral derivative price which occurs if investors maximize their local utility and if derivative demand and supply are balanced. We also introduce the sensitivity process of a contingent claim. This process quantifies the reliability of the neutral derivative price and it can be used to construct price bounds. Moreover, it allows to calibrate market models in order to be consistent with initially observed derivative quotations.

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Authors and Affiliations

  1. Institut für Mathematische Stochastik, Universität Freiburg, Eckerstraße 1, 79104 Freiburg i. Br., Germany (e-mail: kallsen@stochastik.uni-freiburg.de) , , , , , , DE

    Jan Kallsen

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  1. Jan Kallsen
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Manuscript received: October 2000; final version received: February 2001

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Kallsen, J. Derivative pricing based on local utility maximization. Finance Stochast 6, 115–140 (2002). https://doi.org/10.1007/s780-002-8403-x

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  • DOI: https://doi.org/10.1007/s780-002-8403-x

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