Cutting edge introduction: Funding holes in Black-Scholes

HSBC quant builds funding costs and haircuts into Black-Scholes option pricing formula

techtree1

In common with other derivatives, trading options involves funding costs. However, the impact of funding is often ignored entirely or only partially modelled into options prices – an omission that could cause trades to be significantly mispriced, according to Wujiang Lou, a director in global fixed-income trading at HSBC.

In this month's first technical, Funding in option pricing: the Black-Scholes framework extended, Lou offers an extension to the Black-Scholes pricing formula, which takes int

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