Mathematical Finance and Probability Seminars (Since covid these events are taking place online.)

We study the timing of derivative purchases in incomplete markets. In our model, an investor attempts to maximize the spread between her model price and the offered market price through optimally timing her purchase. Both the investor and the market value the options by risk-neutral expectations but under different equivalent martingale measures representing different market views. We show that the structure of the resulting optimal stopping problem depends on the interaction between the respective market price of risk and the option payoff. In particular, a crucial role is played by the delayed purchase premium that is related to the stochastic bracket between the market price and the buyer's risk premia. Explicit characterization of the purchase timing is given for two representative classes of Markovian models: (i) defaultable equity models with local intensity; (ii) diffusion stochastic volatility models. Several numerical examples are presented to illustrate the results. Our model is also applicable in the related contexts of hedging long-dated options and quasi-static hedging.

Speaker: Tim Leung, Johns Hopkins University

Slides: (TBA)