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Traded American options are Bermudan

Traded American options are Bermudan Purpose – The purpose of this paper is to study the importance of business time, and market opening/closing times and days, for American option pricing. Design/methodology/approach – A Bermudan pricing approach is employed whereby the option can be exercised only during the times and days the market is open. The authors apply the approach to the S&P 100 options market. Findings – It was found that the potential biases that can arise from ignoring the non‐continuous operation of the market are not negligible. Research limitations/implications – For expositional purposes, the authors assume that the price of the underlying follows a Geometric Brownian motion. This assumption could be relaxed by future research and more complex price dynamics models could be considered. Practical implications – The findings in this paper could be used in correcting observed option prices, prior to investigating the rationality of early exercise decisions, or in measuring the size of early exercise premia. Originality/value – This is the first study to examine the effects of business time, and market opening/closing times and days, to American option prices. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Managerial Finance Emerald Publishing

Traded American options are Bermudan

Managerial Finance , Volume 37 (11): 7 – Sep 27, 2011

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Publisher
Emerald Publishing
Copyright
Copyright © 2011 Emerald Group Publishing Limited. All rights reserved.
ISSN
0307-4358
DOI
10.1108/03074351111167884
Publisher site
See Article on Publisher Site

Abstract

Purpose – The purpose of this paper is to study the importance of business time, and market opening/closing times and days, for American option pricing. Design/methodology/approach – A Bermudan pricing approach is employed whereby the option can be exercised only during the times and days the market is open. The authors apply the approach to the S&P 100 options market. Findings – It was found that the potential biases that can arise from ignoring the non‐continuous operation of the market are not negligible. Research limitations/implications – For expositional purposes, the authors assume that the price of the underlying follows a Geometric Brownian motion. This assumption could be relaxed by future research and more complex price dynamics models could be considered. Practical implications – The findings in this paper could be used in correcting observed option prices, prior to investigating the rationality of early exercise decisions, or in measuring the size of early exercise premia. Originality/value – This is the first study to examine the effects of business time, and market opening/closing times and days, to American option prices.

Journal

Managerial FinanceEmerald Publishing

Published: Sep 27, 2011

Keywords: Options markets; Stock markets; Financial markets; Prices; American options; Bermudan options; Market microstructure

References