Related papers: Regulatory-Compliant Derivatives Pricing is Not Ri…
Risk-neutral pricing dictates that the discounted derivative price is a martingale in a measure equivalent to the economic measure. The residual ambiguity for incomplete markets is here resolved by minimising the entropy of the price…
Derivative pricing is about cash flow discounting at the riskfree rate. This teaching has lost its meaning post the financial crisis, due to the addition of extra value adjustments (XVA), which also made derivatives pricing and valuation a…
We study the pricing of credit derivatives with asymmetric information. The managers have complete information on the value process of the firm and on the default threshold, while the investors on the market have only partial observations,…
A common assumption in financial engineering is that the market price for any derivative coincides with an objectively defined risk-neutral price - a plausible assumption only if traders collectively possess objective knowledge about the…
Model risk measures consequences of choosing a model in a class of possible alternatives. We find analytical and simulated bounds for payoff functions on classes of plausible alternatives of a given discrete model. We measure the impact of…
This paper presents a new model for pricing financial derivatives subject to collateralization. It allows for collateral arrangements adhering to bankruptcy laws. As such, the model can back out the market price of a collateralized…
As operators acting on the undetermined final settlement of a derivative security, expectation is linear but price is non-linear. When the market of underlying securities is incomplete, non-linearity emerges from the bid-offer around the…
Funding is a cost to trading desks that they see as an input. Current FVA-related literature reflects this by also taking funding costs as an input, usually constant, and always risk-neutral. However, this funding curve is the output from a…
Value adjustment of uncollateralized trades is determined within a risk-neutral pricing framework. When hedging such trades, investors cannot freely trade protection on their own name, thus facing an incomplete market. This fact is…
This article presents a generic model for pricing financial derivatives subject to counterparty credit risk. Both unilateral and bilateral types of credit risks are considered. Our study shows that credit risk should be modeled as American…
In regulatory proceedings, few issues are more hotly debated than the cost of capital. This article formalises the theoretical foundation of cost of capital estimation for regulatory purposes. Several common regulatory practices lack a…
This paper highlights the role of risk neutral investors in generating endogenous bubbles in derivatives markets. We find that a market for derivatives, which has all the features of a perfect market except completeness and has some risk…
The price of electricity is far more volatile than that of other commodities normally noted for extreme volatility. Demand and supply are balanced on a knife-edge because electric power cannot be economically stored, end user demand is…
In this paper we present a rigorously motivated pricing equation for derivatives, including general cash collateralization schemes, which is consistent with quoted market bond prices. Traditionally, there have been differences in how…
A derivative is a financial security whose value is a function of underlying traded assets and market outcomes. Pricing a financial derivative involves setting up a market model, finding a martingale (``fair game") probability measure for…
We study the formation of derivative prices in equilibrium between risk-neutral agents with heterogeneous beliefs about the dynamics of the underlying. Under the condition that the derivative cannot be shorted, we prove the existence of a…
In a market with transaction costs, the price of a derivative can be expressed in terms of (preconsistent) price systems (after Kusuoka (1995)). In this paper, we consider a market with binomial model for stock price and discuss how to…
We consider the problem of how to regulate an oligopoly when firms have private information about their costs. In the environment, consumers make discrete choices over goods, and minimal structure is placed on the manner in which firms…
The objective of this paper is to provide a comprehensive study no-arbitrage pricing of financial derivatives in the presence of funding costs, the counterparty credit risk and market frictions affecting the trading mechanism, such as…
We introduce a criterion how to price derivatives in incomplete markets, based on the theory of growth optimal strategy in repeated multiplicative games. We present reasons why these growth-optimal strategies should be particularly relevant…