The European options hedge perfectly in a Poisson-Gaussian stock market model (Q4551201)

In the real financial markets sudden movements (falls or crashes) in the assets prices are more frequent than one could expect from the Black-Scholes model. Certainly, the jump-diffusion models capture this feature but, in general, perfect hedging is impossible. This paper presents pricing formulae and hedging portfolios, in a frictionless market, for integrable derivative claims when the underlying asset \(S\), a dividend-paying stock, follows a geometric jumping Brownian motion with jumps given by an \(n\)-variate Poisson process with deterministic intensities. The author chooses the primary assets, those available in the market for trade, at every date prior to maturity, \(t<T\), to be a bank account and all the European call options written on \(S\) with maturity \(T\) and any given strike \(K\geq 0\). Assuming that there exists a martingale measure \(Q\) for the discounted price process of the primary assets (which implies the absence of arbitrage opportunities among them) the author proves the existence, for every \(t<T\), of a \(t\)-basis, that is, a set of \(n+1\) primary assets such that the matrix of their volatility coefficients is non-singular almost surely. This implies that the market is complete and, consequently, any contingent claim on \(S\) can be replicated by a self-financing trading strategy formed, at any \(t\), by a combination of the corresponding \(t\)-basis, i. e., a portfolio of European call options on \(S\). Then, the claim discounted price is its \(Q\)-expected value.