Stochastic Dominance Option Pricing: An Alternative Approach to Option Market Research

Description

This book illustrates the application of the economic concept of stochastic dominance to option markets and presents an alternative option pricing paradigm to the prevailing no arbitrage simultaneous equilibrium in the frictionless underlying and option markets. This new methodology was developed primarily by the author, working independently or jointly with other co-authors, over the course of more than thirty years. Among others, it yields the fundamental Black-Scholes-Merton option value when markets are complete, presents a new approach to the pricing of rare event risk, and uncovers option mispricing that leads to tradeable strategies in the presence of transaction costs. In the latter case it shows how a utility-maximizing investor trading in the market and a riskless bond, subject to proportional transaction costs, can increase his/her expected utility by overlaying a zero-net-cost portfolio of options bought at their ask price and written at their bid price, irrespective of the specific form of the utility function. The book contains a unified presentation of these methods and results, making it a highly readable supplement for educators and sophisticated professionals working in the popular field of option pricing. It also features a foreword by George Constantinides, the Leo Melamed Professor of Finance at the Booth School of Business, University of Chicago, USA, who was a co-author in several parts of the book. Front Matter ....Pages i-xxiii Stochastic Dominance: Introduction (Stylianos Perrakis)....Pages 1-17 Stochastic Dominance Option Pricing I: The Frictionless Case (Stylianos Perrakis)....Pages 19-85 Proportional Transaction Costs: An Introduction (Stylianos Perrakis)....Pages 87-109 Stochastic Dominance Option Pricing II: Option Bounds Under Transaction Costs (Stylianos Perrakis)....Pages 111-175 Stochastic Dominance Option Pricing: Empirical Applications (Stylianos Perrakis)....Pages 177-208 Stochastic Dominance and Further Theoretical and Empirical Option Research (Stylianos Perrakis)....Pages 209-252 Conclusions (Stylianos Perrakis)....Pages 253-260 Back Matter ....Pages 261-277