Option Pricing in a Discrete Time Model for the Limit Order Book
48 Pages Posted: 6 Aug 2014
Date Written: July 26, 2014
Abstract
In this paper we build a discrete time model for the structure of the limit order book, so that the price per share depends on the size of the transaction. We deduce the value of a portfolio when the investor trades using market orders and a bank account with different interest rates for lending and borrowing. In this setting, we deduce conditions to rule out arbitrage and solve the problem of pricing and hedging an European call and put option with maturity one and physical delivery. By using primal-dual optimization we show that the price of European options can be written as an optimization problem over some set of probability measures.
Keywords: limit order book; discrete time; option pricing; non arbitrage
JEL Classification: C00, G13
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Optimal Trading Strategy and Supply/Demand Dynamics
By Anna A. Obizhaeva and Jiang Wang
-
Optimal Trading Strategy and Supply/Demand Dynamics
By Anna A. Obizhaeva and Jiang Wang
-
Optimal Trading Strategy and Supply/Demand Dynamics
By Anna A. Obizhaeva and Jiang Wang
-
Optimal Execution Strategies in Limit Order Books with General Shape Functions
By Aurélien Alfonsi, Antje Fruth, ...
-
By Olaf Korn and Alexander Kempf
-
Quasi-Arbitrage and Price Manipulation
By Gur Huberman and Werner Stanzl
-
Fluctuations and Response in Financial Markets: The Subtle Nature of 'Random' Price Changes
By Jean-philippe Bouchaud, Yuval Gefen, ...
-
By Gur Huberman and Werner Stanzl
-
How Markets Slowly Digest Changes in Supply and Demand
By Jean-philippe Bouchaud, J. Doyne Farmer, ...
-
No-Dynamic-Arbitrage and Market Impact
By Jim Gatheral