Munich Personal RePEc Archive

On the pricing and hedging of options for highly volatile periods

El-Khatib, Youssef and Hatemi-J, Abdulnasser (2013): On the pricing and hedging of options for highly volatile periods.

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Abstract

Option pricing is an integral part of modern financial risk management. The well-known Black and Scholes (1973) formula is commonly used for this purpose. This paper is an attempt to extend their work to a situation in which the unconditional volatility of the original asset is increasing during a certain period of time. We consider a market suffering from a financial crisis. We provide the solution for the equation of the underlying asset price as well as finding the hedging strategy. In addition, a closed formula of the pricing problem is proved for a particular case. The suggested formulas are expected to make the valuation of options and the underlying hedging strategies during financial crisis more precise.

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