Minimax and minimal distance martingale measures and their relationship to portfolio optimization (Q5957686)

A common approach to derivative pricing in incomplete markets is to base the prices on a minimal distance martingale measure with respect to certain distances like \(L^2\)-distance, Hellinger distance, entropy distance, etc. In this paper the class of all \(f\)-divergence distances defined by strictly convex differentiable functions \(f\) which includes all the distances mentioned above is considered. A characterization of minimal distance martingale measures with respect to \(f\)-divergence distances in a general semimartingale market model is proposed. This characterization yields some necessary and some sufficient conditions for projections of the considered measures on the set of martingale measures and determine them explicitly for exponential Lévy processes with respect to several classical distances. It is shown that the minimal distance martingale measures are equivalent to minimax martingale measures with respect to related utility functions and that optimal portfolios can be characterized by them. For related results see \textit{H. He} and \textit{N. Pearson} [J. Econ. Theory 54, 259-304 (1991; Zbl 0736.90017)]; \textit{I. Karatzas, J. Lehoczky, S. Shreve} and \textit{G. Xu} [SIAM J. Control Optim. 29, 702-730 (1991; Zbl 0733.93085)]; \textit{D. Kramkov} and \textit{W. Schachermayer} [Ann. Appl. Probab. 9, 904-950 (1999; Zbl 0967.91017)]. Some results are extended to utility-based hedging.