Game options in an imperfect market with default

TL;DR

This paper extends the pricing and superhedging theory of game options to imperfect markets with default, using nonlinear expectations and Dynkin games, and explores robustness under model ambiguity.

Contribution

It introduces a nonlinear framework for pricing and superhedging game options in imperfect markets with default, extending previous perfect market results and addressing model ambiguity.

Findings

Seller's price equals the value of a nonlinear Dynkin game.

Existence of superhedging strategies is established.

Robust seller's price characterized via a mixed Dynkin game.

Abstract

We study pricing and superhedging strategies for game options in an imperfect market with default. We extend the results obtained by Kifer in \cite{Kifer} in the case of a perfect market model to the case of an imperfect market with default, when the imperfections are taken into account via the nonlinearity of the wealth dynamics. We introduce the {\em seller's price} of the game option as the infimum of the initial wealths which allow the seller to be superhedged. We {prove} that this price coincides with the value function of an associated {\em generalized} Dynkin game, recently introduced in \cite{DQS2}, expressed with a nonlinear expectation induced by a nonlinear BSDE with default jump. We moreover study the existence of superhedging strategies. We then address the case of ambiguity on the model, - for example ambiguity on the default probability - and characterize the robust seller's price of a game option as the value function of a {\em mixed generalized} Dynkin game. We study the existence of a cancellation time and a trading strategy which allow the seller to be super-hedged, whatever the model is.