An integer programming model for pricing American contingent claims under transaction costs

Date
2012
Authors
Pınar, M. Ç.
Camcı, A.
Advisor
Supervisor
Co-Advisor
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Source Title
Computational Economics
Print ISSN
0927-7099
Electronic ISSN
1572-9974
Publisher
Volume
39
Issue
1
Pages
1 - 12
Language
English
Type
Article
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Volume Title
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Abstract

We study the problem of computing the lower hedging price of an American contingent claim in a finite-state discrete-time market setting under proportional transaction costs. We derive a new mixed-integer linear programming formulation for calculating the lower hedging price. The linear programming relaxation of the formulation is exact in frictionless markets. Our results imply that it might be optimal for the holder of several identical American claims to exercise portions of the portfolio at different time points in the presence of proportional transaction costs while this incentive disappears in their absence.

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Keywords
American Contingent Claims, Dividends, Hedging, Incomplete Markets, Martingales, Mixed-integer Programming, Pricing, Transaction Costs
Citation
Published Version (Please cite this version)