Root's barrier: construction, optimality and applications to variance options

DOI10.1214/12-AAP857zbMATH Open1266.91101arXiv1104.3583OpenAlexW3100939514MaRDI QIDQ1950255FDOQ1950255

Authors: Jiajie Wang, Alexander Matthew Gordon Cox 

Publication date: 10 May 2013

Published in: The Annals of Applied Probability (Search for Journal in Brave)

Abstract: Recent work of Dupire and Carr and Lee has highlighted the importance of understanding the Skorokhod embedding originally proposed by Root for the model-independent hedging of variance options. Root's work shows that there exists a barrier from which one may define a stopping time which solves the Skorokhod embedding problem. This construction has the remarkable property, proved by Rost, that it minimizes the variance of the stopping time among all solutions. In this work, we prove a characterization of Root's barrier in terms of the solution to a variational inequality, and we give an alternative proof of the optimality property which has an important consequence for the construction of subhedging strategies in the financial context.

Full work available at URL: https://arxiv.org/abs/1104.3583

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zbMATH Keywords

variational inequalitySkorokhod embedding problemvariance optionRoot's barrier

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Diffusion processes (60J60) Stopping times; optimal stopping problems; gambling theory (60G40) Financial applications of other theories (91G80)

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Cited In (49)

• Model-Independent Bounds for Asian Options: A Dynamic Programming Approach
• The geometry of multi-marginal Skorokhod embedding
• The maximum maximum of a martingale with given \(n\) marginals
• Discretisation and duality of optimal Skorokhod embedding problems
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• Robust Framework for Quantifying the Value of Information in Pricing and Hedging
• On the continuity of the Root barrier
• An explicit martingale version of the one-dimensional Brenier theorem
• A free boundary characterisation of the root barrier for Markov processes
• Martingale inequalities for the maximum via pathwise arguments
• Optimal transport with controlled dynamics and free end times
• Bounds for VIX futures given S{\&}P 500 smiles
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