Hedging under arbitrage

DOI10.1111/J.1467-9965.2011.00502.XMaRDI QIDQ4917300zbMATH OpenOpenAlexFDO

Authors Johannes Ruf

Publication date 29 April 2013

Published in Mathematical Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1003.4797

zbMATH Keywords

arbitragebenchmark approachBessel processblackbubblescontinuous timediffusionsFöllmer measurehedginglocal martingalesmarket price of riskoptionspricingput-call-paritySchauder estimatesScholes PDEstochastic discount factorstochastic flowsstochastic portfolio theorytrading strategies

Mathematics Subject Classification ID

Applications of stochastic analysis (to PDEs, etc.) (60H30) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: It is shown that delta hedging provides the optimal trading strategy in terms of minimal required initial capital to replicate a given terminal payoff in a continuous-time Markovian context. This holds true in market models where no equivalent local martingale measure exists but only a square-integrable market price of risk. A new probability measure is constructed, which takes the place of an equivalent local martingale measure. In order to ensure the existence of the delta hedge, sufficient conditions are derived for the necessary differentiability of expectations indexed over the initial market configuration. The recently often discussed phenomenon of "bubbles" is a special case of the setting in this paper. Several examples at the end illustrate the techniques described in this work.

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