Perfect Hedging of Index Derivatives Under a Locally Arbitrage Free Minimal Market Model
AbstractThe paper presents a financial market model that generates stochastic volatility using a minimal set of factors. These factors, formed from transformations of square root processes, model the dynamics of different denominations of a benchmark portfolio. Benchmarked prices are assumed to be local martingales. Numerical results for the pricing and hedging of basic derivatives on indices are described. This includes cases where the standard risk neutral pricing methodology fails. However, payoffs can be perfectly hedged using self-financing strategies and a form of arbitrage still exists. This is illustrated by hedge simulations. The term structure of implied volatilities is documented.
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Bibliographic InfoPaper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 61.
Date of creation: 01 Jun 2001
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derivative pricing; arbitrage; minimal market model;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
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.:
- Eckhard Platen, 2001.
"A Benchmark Model for Financial Markets,"
Research Paper Series
59, Quantitative Finance Research Centre, University of Technology, Sydney.
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