University of Illinois Urbana-Champaign

The effects of transaction costs and different borrowing and lending rates on the option pricing model / BEBR No.874

Gilster, John E.; Lee, William

Permalink

https://hdl.handle.net/2142/26957

Description

Title
The effects of transaction costs and different borrowing and lending rates on the option pricing model / BEBR No.874
Author(s)
  • Gilster, John E.
  • Lee, William
Contributor(s)
  • University of Illinois at Urbana-Champaign. College of Commerce and Business Administration
  • University of Illinois at Urbana-Champaign. Bureau of Economic and Business Research
Issue Date
1982-06
Keyword(s)
Options (Finance)
Abstract
This paper solves a stochastic differential equation to demonstrate that the market imperfections of transaction costs and different borrowing and lending rates partially offset each other to yield a range of equilibrium prices for an option. The Black-Scholes model price is shown to be in the lower portion of, or entirely below, the equilibrium range. These observations are used to explain several of the mythical anomalies found in the option pricing literature. The paper also points out that under some conditions there may be NO equilibrium option price. Instead there may be a bounded disequilibrium within which a single option will offer a risk free return above the Treasury bill rate, while SIMULTANEOUSLY permitting borrowing below the borrowing rate.
Publisher
[Urbana, Ill.] : College of Commerce and Business Administration, Bureau of Economic and Business Research, University of Illinois at Urbana-Champaign,
Series/Report Name or Number
BEBR faculty working paper ; no. 874
Type of Resource
text
Language
eng
Permalink
http://hdl.handle.net/2142/26957
Has Version(s)
  • http://hdl.handle.net/10111/UIUCOCA:effectsoftransac874gils
  • http://www.archive.org/details/effectsoftransac874gils
Copyright and License Information
Copyright June 1982 Board of Trustees University of Illinois.

Owning Collections

Research publications from the University of Illinois at Urbana-Champaign PRIMARY
Research Publications from UIUC