The purpose of this workshop is to develop and analyse pricing and risk management methodology for derivative instruments written on assets that will not be traded. The level of the latter can be fully observed over time but it is either infeasible or undesirable to create a hedging portfolio using the asset.

Examples of such derivatives are:

1. options on commodities or funds where one can at best trade another correlated asset;
2. basket options where instead of the basket components one may prefer to use a correlated index for pricing and risk management;
3. large size options where for liquidity reasons the underlying cannot be used for hedging.

A utility based approach is developed for the specification of indifference price of claims written on non-traded assets. The pricing mechanism is based on the parity between the maximal utilities, with and without employing the derivative. The additional amount gained from granting the option, which renders the investor impartial towards these two scenarios is called the 'indifference price'.

Three alternate measures (historical, risk neutral & indifference) are relevant to the model. The relationship between these measures is elucidated. How to manage the unhedgeable components of risk in the model is an important issue that is also discussed.

References

• M. Musiela and T. Zariphopoulou, Pricing and Risk Managment of Derivatives Written on Non-Traded Assets, February 21, 2001: musiela.pdf.

Please feel free to bring this to the attention of interested colleagues.