Abstract
AbstractThis article considers a novel exotic option pricing method for incomplete markets. Nonparametric predictive inference (NPI) is applied to the option pricing procedure based on the binomial tree model allowing the method to evaluate exotic options with limited information and few assumptions. As the implementation of the NPI method is greatly simplified by the monotonicity of the option payoff in the tree, we categorize exotic options by their payoff monotonicity and study a typical type of exotic option in each category, the barrier option and the look‐back option. By comparison with the classic binomial tree model, we investigate the performance of our method either with different moneyness or varying maturity. All outcomes show that our model offers a feasible approach to price the exotic options with limited information, which makes it can be utilized for both complete and incomplete markets.
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