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Guaranteed Deterministic Approach to Superhedging: Case of Binary European Option

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  • Sergey N. Smirnov
  • Andrey Yu. Zanochkin

Abstract

For the superreplication problem with discrete time, a guaranteed deterministic formulation is considered: the problem is to guarantee coverage of the contingent liability on sold option under all admissible scenarios. These scenarios are defined by means of a priori defined compacts dependent on price prehistory: the price increments at each point in time must lie in the corresponding compacts. In a general case, we consider a market with trading constraints and assume the absence of transaction costs. The formulation of the problem is game theoretic and leads to the Bellman–Isaacs equations. This paper analyses the solution to these equations for a specific pricing problem, i.e., for a binary option of the European type, within a multiplicative market model, with no trading constraints. A number of solution properties and an algorithm for the numerical solution of the Bellman equations are derived. The interest in this problem, from a mathematical prospective, is related to the discontinuity of the option payoff function.

Suggested Citation

  • Sergey N. Smirnov & Andrey Yu. Zanochkin, 2021. "Guaranteed Deterministic Approach to Superhedging: Case of Binary European Option," Abstract and Applied Analysis, John Wiley & Sons, vol. 2021(1).
    • Handle: RePEc:wly:jnlaaa:v:2021:y:2021:i:1:n:5568636
    DOI: 10.1155/2021/5568636
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    References listed on IDEAS

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    4. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
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