Option pricing models without probability: a rough paths approach

DOI10.1111/MAFI.12308MaRDI QIDQ6054388zbMATH OpenOpenAlexFDO

Authors John Armstrong, Claudio Bellani, Damiano Brigo, Thomas Cass

Publication date 28 September 2023

Published in Mathematical Finance (Search for Journal in Brave)

Copyright license Creative Commons Attribution 4.0 International

Full work available at URL https://arxiv.org/abs/1808.09378

zbMATH Keywords

enhanced price pathfundamental theorem of derivatives tradinghistorical vs implied volatilityoption pricingpathwise financepathwise hedgingpathwise pricingprice robustnessprobability-free financerough bracketsrough paths theoryvolatility swaps

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: We describe the pricing and hedging of financial options without the use of probability using rough paths. By encoding the volatility of assets in an enhancement of the price trajectory, we give a pathwise presentation of the replication of European options. The continuity properties of rough-paths allow us to generalise the so-called fundamental theorem of derivative trading, showing that a small misspecification of the model will yield only a small excess profit or loss of the replication strategy. Our hedging strategy is an enhanced version of classical delta hedging where we use volatility swaps to hedge the second order terms arising in rough-path integrals, resulting in improved robustness.

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Cited in

(5)

• Optimal stopping with signatures
• A càdlàg rough path foundation for robust finance
• Probability-free models in option pricing: statistically indistinguishable dynamics and historical vs implied volatility
• A novel portfolio optimization method and its application to the hedging problem
• Gamma hedging and rough paths

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