This paper proposes a numeical approach for computing bounds for the arbitrage-free prices of an option when some options are available for trading. Convex duality reveals a close relationship with recently proposed calibration techniques and implied trees. Our approach is intimatly related to the uncertain volatility model of Avellaneda, Levy and Paras, but it is more general in that it is based on any particular form of the asset price process and does not require the seller's price of an option to be a differentiable function of the cash-flows of the option. Numericaltests on S&P 500 options demonstrate the accuracy and robustness of the proposed method.
By: Alan J. King, Matti Koivu, Teemu Pennanen
Published in: RC22810 in 2003
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