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August, 1993 The Russian Option: Reduced Regret
Larry Shepp, A. N. Shiryaev
Ann. Appl. Probab. 3(3): 631-640 (August, 1993). DOI: 10.1214/aoap/1177005355

Abstract

We propose a new put option where the option buyer receives the maximum price (discounted) that the option has ever traded at during the time period (which may be indefinitely long) between the purchase time and the exercise time, so that the buyer need look at the fluctuations only occasionally and enjoys having little or no regret that he did not exercise the option at an earlier time (except for the discounting). We give an exact simple formula for the optimal expected present value (fair price) that can be derived from the option and the (unique) optimal exercise strategy that achieves the optimum value under the assumption that the asset fluctuations follow the Black-Scholes exponential Brownian motion model, which is widely accepted. It is important to note that the discounting is necessary: If it is omitted or even if it is less than the Black-Scholes drift, then the value to the buyer under optimum performance is infinite. We also solve the same problem under a different model: the original Bachelier linear Brownian market with linear discounting. This model is no longer accepted, but of course the mathematics is consistent. To our knowledge no such regretless option is currently traded in any existing market despite its evident appeal. We call it the Russian option, partly to distinguish it from the American and European options, where the term of the option is prescribed in advance and where no exact formula for the value has been given.

Citation

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Larry Shepp. A. N. Shiryaev. "The Russian Option: Reduced Regret." Ann. Appl. Probab. 3 (3) 631 - 640, August, 1993. https://doi.org/10.1214/aoap/1177005355

Information

Published: August, 1993
First available in Project Euclid: 19 April 2007

zbMATH: 0783.90011
MathSciNet: MR1233617
Digital Object Identifier: 10.1214/aoap/1177005355

Subjects:
Primary: 90A09
Secondary: 60G44 , 60H30

Keywords: Black-Scholes model , linear discounting , optimal strategy , Options

Rights: Copyright © 1993 Institute of Mathematical Statistics

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Vol.3 • No. 3 • August, 1993
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