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Arbitrage-Free Conditions and Hedging Strategies for Markets with Penalty Costs on Short Positions

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  • O. L. V. Costa
  • E. V. Queiroz Filho

Abstract

We consider a discrete-time financial model in a general sample space with penalty costs on short positions. We consider a friction market closely related to the standard one except that withdrawals from the portfolio value proportional to short positions are made. We provide necessary and sufficient conditions for the nonexistence of arbitrages in this situation and for a self-financing strategy to replicate a contingent claim. For the finite-sample space case, this result leads to an explicit and constructive procedure for obtaining perfect hedging strategies.

Suggested Citation

  • O. L. V. Costa & E. V. Queiroz Filho, 2012. "Arbitrage-Free Conditions and Hedging Strategies for Markets with Penalty Costs on Short Positions," Mathematical Problems in Engineering, Hindawi, vol. 2012, pages 1-20, March.
    • Handle: RePEc:hin:jnlmpe:937324
    DOI: 10.1155/2012/937324
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