OPTION REPLICATION IN DISCRETE-TIME WITH TRANSACTION COSTS

Option replication is discussed in a discrete-time framework with tran saction costs. The model represents an extension of the Cox-Ross-Rubin stein binomial option pricing model to cover the case of proportional transaction costs. The method proceeds by constructing the appropriate replicating portfolio at each trading interval. Numerical values of t hese prices are presented for a range of parameter values. The paper d erives a simple Black-Scholes type approximation for the option prices with transaction costs and demonstrates numerically that it is quite accurate for plausible parameter values.