A0728
Title: Model-free bounds for option prices in incomplete markets
Authors: Yannick Dillschneider - University of Amsterdam (Netherlands) [presenting]
Abstract: A methodology is developed to quantify the uncertainty about option prices that persists in (statically) incomplete option markets due to finite strike and maturity grids as well as bid-ask price quoting. Uncertainty measures are provided for European option prices and their slopes (i.e., tail probabilities), each derived from model-free bounds that are consistent with a finite sample of observed bid and ask option prices and elementary no-arbitrage constraints in a multi-period setting. Novel explicit expressions are obtained for these bounds, which are simple and efficient to compute. Moreover, a decomposition of the bounds and uncertainty measures into contributions of strike, maturity, and price quote incompleteness is suggested. In an empirical analysis of S\&P 500 index options, the empirical uncertainty about option prices is quantified. Sizable uncertainty levels are documented for option prices and tail probabilities. Findings challenge the common belief that such "option-implied" (tail) information can be measured at sufficiently high precision, which has implications for many applications that use this information.
