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Game options with gradual exercise and cancellation under proportional transaction costs

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JournalStochastics: An International Journal of Probability and Stochastic Processes
DateAccepted/In press - 6 Jul 2018
DateE-pub ahead of print (current) - 24 Jul 2018
Issue number8
Volume90
Number of pages31
Early online date24/07/18
Original languageEnglish

Abstract

Game (Israeli) options in a multi-asset market model with proportional transaction costs are studied in the case when the buyer is allowed to exercise the option and the seller has the right to cancel the option gradually at a mixed (or randomised) stopping time, rather than instantly at an ordinary stopping time. Allowing gradual exercise and cancellation leads to increased flexibility in hedging, and hence tighter bounds on the option price as compared to the case of instantaneous exercise and cancellation. Algorithmic constructions for the bid and ask prices, and the associated superhedging strategies and optimal mixed stopping times for both exercise and cancellation are developed and illustrated. Probabilistic dual representations for bid and ask prices are also established.

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