By Professor Alexandre Ziegler (auth.)
Modern alternative pricing concept was once constructed within the past due sixties and early seventies through F. Black, R. e. Merton and M. Scholes as an analytical instrument for pricing and hedging alternative contracts and over the counter warrants. How ever, already within the seminal paper by means of Black and Scholes, the applicability of the version was once considered as a lot broader. within the moment a part of their paper, the authors confirmed levered firm's fairness might be considered as an alternative at the price of the enterprise, and hence might be priced through alternative valuation strategies. A 12 months later, Merton confirmed how the default chance constitution of cor porate bonds might be decided by means of alternative pricing concepts. choice pricing versions at the moment are used to cost almost the entire diversity of economic tools and fiscal promises similar to deposit assurance and collateral, and to quantify the linked dangers. through the years, alternative pricing has developed from a suite of particular versions to a normal analytical framework for interpreting the construction technique of monetary contracts and their functionality within the monetary intermediation approach in a continuing time framework. in spite of the fact that, only a few makes an attempt were made within the literature to combine online game thought features, i. e. strategic monetary judgements of the brokers, into the continual time framework. this can be the original contribution of the thesis of Dr. Alexandre Ziegler. taking advantage of the analytical tractability of contin uous time types and the closed shape valuation versions for derivatives, Dr.
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Extra info for A Game Theory Analysis of Options: Corporate Finance and Financial Intermediation in Continuous Time
1 The Model Consider a financial intermediary (which we shall also call the lender or the principal) that lends money to a borrower (or agent) for investment in one of many projects that are available only to the borrower. Assurne that the lender cannot observe the borrower's project choice (or that the cost of doing so is prohibitively high), and therefore cannot assess the risk of the project. At initial time, all projects have the same (fair) price So, but different risks. The project values then evolve according to geometrie Brownian motions.
This is the so-called risk-shifting or asset substitution problem, which was first laid out by Jensen and Meckling [451. - In contrast, in a situation of hidden information, the agent privately observes the true state of the world prior to choosing an observable action. In the context of financial contracting, the borrower typically is the only person that can observe project returns at no cost. To the extent that his promised payment depends positivelyon realized project return, he might have an incentive to understate project return in order to reduce his payment to the lender.
Which one should the lender and the borrower select? To answer this question, let us introduce the concept of a renegotiation-proof incentive contract. 4 Renegotiation-Proof Incentive Contracts The classical moral hazard literature uses the term renegotiation-proof to describe a contract that is never revised. 5 Renegotiation-proof contracts are intuitively appealing. To the extent that renegotiation involves costs, both principal and agent will be able to gain if they can agree on a contract that assures proper incentives over its whole life.