Transaction costs and option prices

Article type: Research Article

Authors: Perrakis, Stylianos

Affiliations: The John Molson School of Business, Concordia University, MB 12.305, 1450 Guy Street, Montreal, Quebec, H3H 2L5, Canada. E-mail: stylianos.perrakis@concordia.ca

Abstract: Option prices are characterized by wide bid-ask spreads, much wider than the spreads of their underlying assets. This note discusses the various attempts to rationalize and link the two markets’ spreads with each other and explains why their failures are mainly due to the inability to accommodate trading frictions in theoretical asset pricing models. It also presents in summary form the partial results from the stochastic dominance approach to option pricing under proportional transaction costs that provide bounds for the spreads for index call options.

Keywords: Transaction costs, option pricing, asset allocation, stochastic dominance, option bounds

DOI: 10.3233/RDA-170125

Journal: Risk and Decision Analysis, vol. 6, no. 3, pp. 241-248, 2017