Risk-based indifference pricing under a stochastic volatility model

Robert J. Elliott, Tak Kuen Siu

Research output: Contribution to journalArticlepeer-review

Abstract

This paper considers a risk-based approach for indifference valuation of contingent claims in the context of a continuous-time stochastic volatility model. Since the market in the model is incomplete there is more than one arbitrage-free price of an option. We adopt a risk-based approach to select a seller's and a buyer's indifference price for the option contract. A convex risk measure is used to measure risk. We formulate the valuation problems as two-person, zero-sum, stochastic differential games. Two approaches, namely, the dynamic programming principle and the maximum principle, are used to find the solutions to the games.
Original languageEnglish
Pages (from-to)51-73
Number of pages23
JournalCommunications on stochastic analysis
Volume4
Issue number1
Publication statusPublished - 2010

Keywords

  • Option pricing
  • Stochastic volatility model
  • Indifference prices
  • Convex risk measures
  • Stochastic differential games
  • Dynamic programming
  • Maximum principle

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