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Duplicating Contingent Claims by the Lagrange Method

  • Gregory C. Chow

    (Princeton University)

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    The problem of investing y(0) dollars at time 0 to duplicate a contigent claim is formulated as a dynamic optimization problem and solved by the Langrange method. If the function defining dy(t) is concave in y(t), owing to costs of trading in incomplete markets, there is an economy of scale in producing many claims simultaneously, thus explaining the profitability of institutions in providing such financial services.

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    File URL: http://econwpa.repec.org/eps/fin/papers/0306/0306004.pdf
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    Paper provided by EconWPA in its series Finance with number 0306004.

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    Date of creation: 10 Jun 2003
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    Handle: RePEc:wpa:wuwpfi:0306004
    Note: Published in Pacific Economic Review, 4:3 (1999)
    Contact details of provider: Web page: http://econwpa.repec.org

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    1. Chow, Gregory C., 1997. "Dynamic Economics: Optimization by the Lagrange Method," OUP Catalogue, Oxford University Press, number 9780195101928.
    2. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    3. Harrison, J. Michael & Pliska, Stanley R., 1981. "Martingales and stochastic integrals in the theory of continuous trading," Stochastic Processes and their Applications, Elsevier, vol. 11(3), pages 215-260, August.
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