Pricing and Hedging Options in Incomplete Markets: Idiosyncratic Risk, Systematic Risk and Stochastic Volatility
AbstractStarting from the European option valuation framework of Chauveau and Gatfaoui (2002), we establish the link with stochastic volatility models. And, we propose both a new vision and a general framework for valuing European options in the light of systematic and idiosyncratic risks affecting risky assets in the financial market. Therefore, we account for the well-known volatility smile in the light of the literature addressing the determinants of the smile effect among which stochastic volatility and market risk. We further discuss briefly the hedging of European options along with the local risk minimization principle. Specifically, we attempt to find a strategy which dominates the usual partial hedging technique often imposed by market's incompleteness.
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Bibliographic InfoPaper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 122.
Date of creation: 01 Apr 2004
Date of revision:
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call pricing; idiosyncratic risk; incomplete market; stochastic volatility; systematic risk;
Other versions of this item:
- Gatfaoui Hayette & Chauveau Thierry, 2004. "Pricing and Hedging Options in Incomplete Markets: Idiosyncratic Risk, Systematic Risk and Stochastic Volatility," Finance 0404002, EconWPA.
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-08-16 (All new papers)
- NEP-FIN-2004-08-16 (Finance)
- NEP-FMK-2004-06-02 (Financial Markets)
- NEP-RMG-2004-08-16 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Discussion Paper Serie B
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