101. Optionality as a binary operation.
- Author
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Carr, Peter and Costa, Doug
- Subjects
BINARY operations ,CONVERTIBLE bonds ,STOCKS (Finance) ,PRICES ,DISTRIBUTION (Probability theory) - Abstract
In finance, optionality is a possible property of a financial contract giving the owner a choice between two or more assets. For example, a convertible bond has optionality because its owner must choose between having a bond or having some shares of stock. In mathematics, a binary operation acts on two elements in a set to produce a third element in that set. When a financial contract such as a convertible bond enjoys optionality between exactly two assets, then the arbitrage-free current value of the contract can potentially be treated as the outcome of a binary operation acting on the two current asset values. In this paper, we treat one of the two assets as riskless and demand that the binary operation linking the two current asset values always produces an arbitrage-free option price. In this context, we focus on the interplay between the properties of the risk-neutral density of the risky asset and the algebraic properties of the binary operation. [ABSTRACT FROM AUTHOR]
- Published
- 2023
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