We introduce a discrete binary tree for pricing contingent claims with theunderlying security prices exhibiting history dependence characteristic of thatinduced by market microstructure phenomena. Example dependencies consideredinclude moving average or autoregressive behavior. Our model ismarket-complete, arbitrage-free, and preserves all of the parameters governingthe historical (natural world) price dynamics when passing to an equivalentmartingale (risk-neutral) measure. Specifically, this includes theinstantaneous mean and variance of the asset return and the instantaneousprobabilities for the direction of asset price movement. We believe this is thefirst paper to demonstrate the ability to include market microstructure effectsin dynamic asset/option pricing in a market-complete, no-arbitrage, format.
Unifying Market Microstructure and Dynamic Asset Pricing
Davide Lauria
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2023-01-01
Abstract
We introduce a discrete binary tree for pricing contingent claims with theunderlying security prices exhibiting history dependence characteristic of thatinduced by market microstructure phenomena. Example dependencies consideredinclude moving average or autoregressive behavior. Our model ismarket-complete, arbitrage-free, and preserves all of the parameters governingthe historical (natural world) price dynamics when passing to an equivalentmartingale (risk-neutral) measure. Specifically, this includes theinstantaneous mean and variance of the asset return and the instantaneousprobabilities for the direction of asset price movement. We believe this is thefirst paper to demonstrate the ability to include market microstructure effectsin dynamic asset/option pricing in a market-complete, no-arbitrage, format.I documenti in IRIS sono protetti da copyright e tutti i diritti sono riservati, salvo diversa indicazione.
