Pseudo--Arbitrage - A new Approach to Pricing and Hedging in Incomplete Markets
We develop a new approach to pricing and hedging contingent claims in incomplete markets. Mimicking as closely as possible in an incomplete markets framework the no--arbitrage arguments that have been developed in complete markets leads us to defining the concept of pseudo--arbitrage. Building on this concept we are able to extend the no--arbitrage idea to a world of incomplete markets in such a way that based on a concept of risk compatible with the axioms of Artzner et al. we can derive unique prices and corresponding optimal hedging strategies without invoking specific assumptions on preferences (other than monotonicity and risk aversion). Price processes of contingent claims are martingales under a unique martingale measure. A comparison to a version of the Hull and White stochastic volatility model shows that in contrast to their approach explicitly taking into account optimal hedging strategies leads to positive market prices of risk for volatility even if the latter is instantaneously uncorrelated with the stock price process. Our results are, however, in agreement with the findings of Lamoureux and Lastrapes.
|Date of creation:||Nov 1998|
|Date of revision:|
|Contact details of provider:|| Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany|
Fax: +49 228 73 6884
Web page: http://www.bgse.uni-bonn.de
References listed on IDEAS
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.:
- Stein, Elias M & Stein, Jeremy C, 1991. "Stock Price Distributions with Stochastic Volatility: An Analytic Approach," Review of Financial Studies, Society for Financial Studies, vol. 4(4), pages 727-52.
When requesting a correction, please mention this item's handle: RePEc:bon:bonsfb:442. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (BGSE Office)
If references are entirely missing, you can add them using this form.