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Real-world options: smile and residual risk

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Author Info
Jean-Philippe Bouchaud (Science & Finance, Capital Fund Management)
Giulia Iori
Didier Sornette (UCLA)

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Abstract

We present a theory of option pricing and hedging, designed to address non-perfect arbitrage, market friction and the presence of `fat' tails. An implied volatility `smile' is predicted. We give precise estimates of the residual risk associated with optimal (but imperfect) hedging.

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Paper provided by Science & Finance, Capital Fund Management in its series Science & Finance (CFM) working paper archive with number 500039.

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Date of creation: Sep 1995
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Publication status: Published in Risk Magazine 9 (3), 61-65, (March 1996)
Handle: RePEc:sfi:sfiwpa:500039

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G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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  1. Rama CONT, 1998. "Beyond implied volatility: extracting information from option prices," Finance 9804002, EconWPA. [Downloadable!]
  2. Marco Airoldi & Vito Antonelli & Bruno Bassetti & Andrea Martinelli & Marco Picariello, 2004. "Long Range Interaction Generating Fat-Tails in Finance," GE, Growth, Math methods 0404006, EconWPA, revised 27 Apr 2004. [Downloadable!]
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