Pricing and Hedging Derivative Securities in Incomplete Markets: An E-Aritrage Model / Dimitris Bertsimas, Leonid Kogan, Andrew W. Lo.

Format:

Book

Author/Creator:

Bertsimas, Dimitris.

Contributor:

National Bureau of Economic Research.

Kogan, Leonid.

Lo, Andrew W.

Series:

Working Paper Series (National Bureau of Economic Research) no. w6250.

NBER working paper series no. w6250

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Pricing and Hedging Derivative Securities in Incomplete Markets

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1997.

Summary:

Given a European derivative security with an arbitrary payoff function and a corresponding set of" underlying securities on which the derivative security is based, we solve the dynamic replication problem: find a" self-financing dynamic portfolio strategy involving only the underlying securities that most closely" approximates the payoff function at maturity. By applying stochastic dynamic programming to the minimization of a" mean-squared-error loss function under Markov state-dynamics, we derive recursive expressions for the optimal-replication strategy that are readily implemented in practice. The approximation error or " " of the optimal-replication strategy is also given recursively and may be used to quantify the "degree" of market incompleteness. " To investigate the practical significance of these -arbitrage strategies examples including path-dependent options and options on assets with stochastic volatility and jumps. "

Notes:

Print version record

November 1997.