Leland's Approximations for Concave Pay-Off Functions
Lépinette, Emmanuel (2009), Leland's Approximations for Concave Pay-Off Functions, in Kijima, Masaaki; Kabanov, Yuri, Recent advances in financial engineering, proceedings of the 2008 Daiwa International Workshop on Financial Engineering, World Scientific, p. 107-117
TypeCommunication / Conférence
Conference titleDaiwa International Workshop on Financial Engineering
Book titleRecent advances in financial engineering, proceedings of the 2008 Daiwa International Workshop on Financial Engineering
Book authorKijima, Masaaki; Kabanov, Yuri
Number of pages230
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Abstract (EN)In 1985, Leland suggested an approach to pricing contingent claims under proportional transaction costs. Its main idea is to use the classical Black–Scholes formula with a suitably enlarged volatility for a periodically revised portfolio which terminal value approximates the pay-off h(ST). In subsequent studies, Lott (for α = 1/2), Kabanov and Safarian proved that for the call-option, i.e. for h(x) = (x-K)+, Leland's portfolios, indeed, approximate the pay-off if the transaction costs coefficients decreases as n-α for α ∈ ]0, 1/2] where n is the number of revisions. These results can be extended to the case of more general pay-off functions and non-uniform revision intervals . Unfortunately, the terminal values of portfolios do not converge to the pay-off if h is not a convex function. In this paper, we show that we can slightly modify the Leland strategy such that the convergence holds for a large class of concave pay-off functions if α = 1/2.
Subjects / KeywordsBlack–Scholes formula; Transaction costs; Leland's strategy; Approximate hedging
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Diffusion equations: convergence of the functional scheme derived from the Binomial tree with local volatility for non smooth payoff functions Baptiste, Julien; Lépinette, Emmanuel (2018) Article accepté pour publication ou publié