2021/01/01 by Kevin Shuai Zhang, Zhang, Kevin Shuai, Traian A. Pirvu +1
Economics, Econometrics and Finance · #91G20 #91G60 #Computational Finance (q-fin.CP) #FOS: Economics and business #Financial Markets and Investment Strategies #Financial Risk and Volatility Modeling #G.1.8 #I.2.m #J.2 #Stochastic processes and financial applications
paper · pdf · doi:10.48550/arxiv.2101.00223
openalex publication_date 2021/01/01 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28
We study the pricing and hedging of European spread options on correlated assets when, in contrast to the standard framework and consistent with imperfect liquidity markets, the trading in the stock market has a direct impact on stocks prices. We consider a partial-impact and a full-impact model in which the price impact is caused by every trading strategy in the market. The generalized Black-Scholes pricing partial differential equations (PDEs) are obtained and analysed. We perform a numerical analysis to exhibit the illiquidity effect on the replication strategy of the European spread option. Compared to the Black-Scholes model or a partial impact model, the trader in the full impact model buys more stock to replicate the option, and this leads to a higher option price.