Robust pricing and hedging under trading restrictions and the emergence of local martingale models

DOI10.1007/S00780-016-0293-3zbMATH Open1369.91175DBLPjournals/fs/CoxHO16arXiv1406.0551OpenAlexW2096772538WikidataQ59474920 ScholiaQ59474920MaRDI QIDQ309166FDOQ309166

Jan Obłój, Zhaoxu Hou, Alexander Matthew Gordon Cox

Publication date: 7 September 2016

Published in: Finance and Stochastics (Search for Journal in Brave)

Abstract: We consider the pricing of derivatives in a setting with trading restrictions, but without any probabilistic assumptions on the underlying model, in discrete and continuous time. In particular, we assume that European put or call options are traded at certain maturities, and the forward price implied by these option prices may be strictly decreasing in time. In discrete time, when call options are traded, the short-selling restrictions ensure no arbitrage, and we show that classical duality holds between the smallest super-replication price and the supremum over expectations of the payoff over all supermartingale measures. More surprisingly in the case where the only vanilla options are put options, we show that there is a duality gap. Embedding the discrete time model into a continuous time setup, we make a connection with (strict) local-martingale models, and derive framework and results often seen in the literature on financial bubbles. This connection suggests a certain natural interpretation of many existing results in the literature on financial bubbles.

Full work available at URL: https://arxiv.org/abs/1406.0551

zbMATH Keywords

financial bubblelocal martingale modelsmartingale optimal transportpricing-hedging dualityrobust pricing and hedgingshort selling constrainttrading restrictions

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Martingales with continuous parameter (60G44) Actuarial science and mathematical finance (91G99)

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Uses Software

• Mathematica

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