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The McCormick martingale optimal transport

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  • Erhan Bayraktar
  • Bingyan Han
  • Dominykas Norgilas

Abstract

Martingale optimal transport (MOT) often yields broad price bounds for options, constraining their practical applicability. In this study, we extend MOT by incorporating causality constraints among assets, inspired by the nonanticipativity condition of stochastic processes. However, this introduces a computationally challenging bilinear program. To tackle this issue, we propose McCormick relaxations to ease the bicausal formulation and refer to it as McCormick MOT. The primal attainment and strong duality of McCormick MOT are established under standard assumptions. Empirically, McCormick MOT demonstrates the capability to narrow price bounds, achieving an average reduction of 1% or 4%. The degree of improvement depends on the payoffs of the options and the liquidity of the relevant vanilla options.

Suggested Citation

  • Erhan Bayraktar & Bingyan Han & Dominykas Norgilas, 2024. "The McCormick martingale optimal transport," Papers 2401.15552, arXiv.org.
  • Handle: RePEc:arx:papers:2401.15552
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    File URL: http://arxiv.org/pdf/2401.15552
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