| In this dissertation, we propose a generalized discrete-time, discrete-space framework for valuing options when there are transaction costs in the underlying assets. We present the Optimal Hedge Pricing approach, which combines the concepts of utility maximization and arbitrage-free option pricing via a replication argument. On one hand, when there is no transaction cost Optimal Hedge Pricing is equivalent to the popular arbitrage-free pricing approach in Financial Economics. On the other hand, as the transaction cost becomes sufficiently high to preclude trading in the underlying assets, the Optimal Hedge Pricing approach simplifies to the Certainty Equivalent Pricing approach in Decision Analysis. For an efficient and straightforward numerical procedure, we offer a stochastic linear programming formulation that fares well with the framework of Optimal Hedge Pricing. |
