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Derivatives pricing with liquidity risk
Author(s) -
Zhang Yongmin,
Ding Shusheng,
Duygun Meryem
Publication year - 2019
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.22008
Subject(s) - market liquidity , futures contract , derivative (finance) , liquidity risk , model risk , valuation (finance) , derivatives market , economics , benchmark (surveying) , financial economics , flexibility (engineering) , econometrics , hedge , computer science , business , risk management , monetary economics , finance , ecology , management , geodesy , biology , geography
This paper develops a novel, general derivative pricing model which introduces a liquidity risk factor. The model variants we outline offer a sufficient degree of flexibility so as to enable the valuation of various types of derivative classes including futures, American options, and mortgage backed security options, whereas existing derivative models can only price liquidity risk in European derivatives. We validate the model with oil and gold futures data and compare it to a classical benchmark model void of any liquidity risk. We find that our model is significantly more accurate than the classical model for pricing both oil and gold contracts.