On asset pricing in a binomial model with fixed and proportional transaction costs, portfolio constraints and dividends

Babaei, Esmaeil ORCID: https://orcid.org/0000-0002-1607-2338 (2024) On asset pricing in a binomial model with fixed and proportional transaction costs, portfolio constraints and dividends. Mathematical Methods of Operations Research. ISSN 1432-2994

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Abstract

We extend the classical binomial model proposed by Cox, Ross, and Rubinstein for derivative security pricing to encompass both fixed and proportional transaction costs, portfolio constraints including margin requirements, and dividend-paying assets. Our focus is on studying option hedging within this enriched framework. Initially, we establish the existence of a hedging strategy in this context. Subsequently, we determine the optimal hedging strategy and its associated initial cost by decomposing the problem into a sequence of hedging problems. To illustrate our approach, we present a numerical example within a 3-period binomial model.