Derivatives pricing with liquidity risk

Zhang, Y; Ding, S; Duygun, Meryem

Abstract

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 MBS options, while 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.

Citation

Zhang, Y., Ding, S., & Duygun, M. (2019). Derivatives pricing with liquidity risk. Journal of Futures Markets, 39(11), 1471-1485. https://doi.org/10.1002/fut.22008

• Journal Article Type: Article
• Acceptance Date: Mar 7, 2019
• Online Publication Date: Apr 1, 2019
• Publication Date: 2019-11
• Deposit Date: Mar 5, 2019
• Publicly Available Date: Apr 2, 2021
• Journal: Journal of Futures Markets
• Print ISSN: 0270-7314
• Electronic ISSN: 1096-9934
• Publisher: Wiley
• Peer Reviewed: Peer Reviewed
• Volume: 39
• Issue: 11
• Pages: 1471-1485
• DOI: https://doi.org/10.1002/fut.22008
• Keywords: Derivative Pricing, Liquidity Risk Factor, Futures Contracts
• Public URL: https://nottingham-repository.worktribe.com/output/1607213
• Publisher URL: https://onlinelibrary.wiley.com/doi/full/10.1002/fut.22008
• Additional Information: This is the peer reviewed version of the following article: Zhang, Y, Ding, S, Duygun, M. Derivatives pricing with liquidity risk. J Futures Markets. 2019; 1– 15, which has been published in final form at https://doi.org/10.1002/fut.22008. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Use of Self-Archived Versions.
• Contract Date: Mar 5, 2019