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Semi-Static Hedging Of Barrier Options Under Poisson Jumps

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  • PETER CARR

    ()
    (NYU Courant Institute, 251 Mercer Street, New York, NY 10012, USA)

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    Abstract

    We show that the payoff to barrier options can be replicated when the underlying price process is driven by the difference of two independent Poisson processes. The replicating strategy employs simple semi-static positions in co-terminal standard options. We note that classical dynamic replication using just the underlying asset and a riskless asset is not possible in this context. When the underlying of the barrier option has no carrying cost, we show that the same semi-static trading strategy continues to replicate even when the two jump arrival rates are generalized into positive even functions of distance to the barrier and when the clock speed is randomized into a positive continuous independent process. Since the even function and the positive process need no further specification, our replicating strategies are also semi-robust. Finally, we show that previous results obtained for continuous processes arise as limits of our analysis.

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    Bibliographic Info

    Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

    Volume (Year): 14 (2011)
    Issue (Month): 07 ()
    Pages: 1091-1111

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    Handle: RePEc:wsi:ijtafx:v:14:y:2011:i:07:p:1091-1111

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    Related research

    Keywords: Static replication; barrier options; hedging jump processes; robust valuation; Poisson processes; arbitrage;

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