2009/07/27 by Erik Ekström, Johan Tysk
Economics, Econometrics and Finance · Mathematics · #Capital Investment and Risk Analysis #Economic theories and models #Stochastic processes and financial applications #math.PR #msc:35K65 #msc:60G40 #msc:60G44 #msc:91B28
paper · pdf · doi:10.1214/08-aap579
published as Annals of Applied Probability 2009, Vol. 19, No. 4, 1369-1384 · Published in at http://dx.doi.org/10.1214/08-AAP579 the Annals of Applied Probability (http://www.imstat.org/aap/) by the Institute of Mathematical Statistics (http://www.imstat.org)
arxiv created 2009/08/31 · arxiv updated 2009/12/01
A bubble is characterized by the presence of an underlying asset whose discounted price process is a strict local martingale under the pricing measure. In such markets, many standard results from option pricing theory do not hold, and in this paper we address some of these issues. In particular, we derive existence and uniqueness results for the Black--Scholes equation, and we provide convexity theory for option pricing and derive related ordering results with respect to volatility. We show that American options are convexity preserving, whereas European options preserve concavity for general payoffs and convexity only for bounded contracts.