Pathwise no-arbitrage in a class of delta hedging strategies

DOI10.1186/S41546-016-0003-2MaRDI QIDQ2296083zbMATH OpenOpenAlexWikidataFDO

Authors Iryna Voloshchenko, Alexander Schied

Publication date 17 February 2020

Published in Probability, Uncertainty and Quantitative Risk (Search for Journal in Brave)

Copyright license Creative Commons Attribution 4.0 International

Full work available at URL https://arxiv.org/abs/1511.00026

zbMATH Keywords

exotic optionsFöllmer integralfunctional Cauchy problem on path spacefunctional Itô formulalocal volatilitypathwise arbitragepathwise hedgingpathwise Itô calculus

Mathematics Subject Classification ID

Stochastic integrals (60H05) Applications of stochastic analysis (to PDEs, etc.) (60H30) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: We consider a strictly pathwise setting for Delta hedging exotic options, based on F"ollmer's pathwise It=o calculus. Price trajectories are $d$-dimensional continuous functions whose pathwise quadratic variations and covariations are determined by a given local volatility matrix. The existence of Delta hedging strategies in this pathwise setting is established via existence results for recursive schemes of parabolic Cauchy problems and via the existence of functional Cauchy problems on path space. Our main results establish the nonexistence of pathwise arbitrage opportunities in classes of strategies containing these Delta hedging strategies and under relatively mild conditions on the local volatility matrix.

Recommendations

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• Exploding hedging errors for digital options

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