Consistent Pricing and Hedging for a Modified Constant Elasticity of Variance Model
This paper considers a modification of the well-known constant elasticity of variance model where it is used to model the growth optimal portfolio. It is shown taht, for this application, there is no equivalent risk neutral pricing methodology fails. However, a consistent pricing and hedging framework can be established by application of the benchmark approach. Perfect hedging strategies can be constructed for European style contingent claims, where the underlying risky asset is the growth optimal portfolio. In this framework, fair prices for contingent claims are the minimal prices that permit perfect replication of the claims. Numerical examples show that these prices may differ significantly from the corresponding "risk neutral" prices. In cases where these prices are different, arbitrage amounts can be generated.
|Date of creation:||01 May 2002|
|Publication status:||Published as: Heath, D. and Platen, E., 2002, "Consistent Pricing and Hedging for a Modified Constant Elasticity of Variance Model", Quantitative Finance, 2(6), 459-467.|
|Contact details of provider:|| Postal: PO Box 123, Broadway, NSW 2007, Australia|
Phone: +61 2 9514 7777
Fax: +61 2 9514 7711
Web page: http://www.qfrc.uts.edu.au/
More information through EDIRC
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.:
- Schroder, Mark Douglas, 1989. " Computing the Constant Elasticity of Variance Option Pricing Formula," Journal of Finance, American Finance Association, vol. 44(1), pages 211-219, March.
- Beckers, Stan, 1980. " The Constant Elasticity of Variance Model and Its Implications for Option Pricing," Journal of Finance, American Finance Association, vol. 35(3), pages 661-673, June.
- Leif Andersen & Jesper Andreasen, 2000. "Volatility skews and extensions of the Libor market model," Applied Mathematical Finance, Taylor & Francis Journals, vol. 7(1), pages 1-32.
- Platen, Eckhard, 2000.
"A minimal financial market model,"
SFB 373 Discussion Papers
2000,91, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
- Eckhard Platen, 2001. "A Minimal Financial Market Model," Research Paper Series 48, Quantitative Finance Research Centre, University of Technology, Sydney.
- Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
- Alan L. Lewis, 2000. "Option Valuation under Stochastic Volatility," Option Valuation under Stochastic Volatility, Finance Press, number ovsv.
- Long, John Jr., 1990. "The numeraire portfolio," Journal of Financial Economics, Elsevier, vol. 26(1), pages 29-69, July.
- Eckhard Platen, 2001. "Arbitrage in Continuous Complete Markets," Research Paper Series 72, Quantitative Finance Research Centre, University of Technology, Sydney. Full references (including those not matched with items on IDEAS)