Option Pricing and Hedging with Temporal Correlations
Condensed Matter
2007-05-23 v1
Abstract
We consider the problem of option pricing and hedging when stock returns are correlated in time. Within a quadratic-risk minimisation scheme, we obtain a general formula, valid for weakly correlated non-Gaussian processes. We show that for Gaussian price increments, the correlations are irrelevant, and the Black-Scholes formula holds with the volatility of the price increments on the scale of the re-hedging. For non-Gaussian processes, further non trivial corrections to the `smile' are brought about by the correlations, even when the hedge is the Black-Scholes Delta-hedge. We introduce a compact notation which eases the computations and could be of use to deal with more complicated models.
Keywords
Cite
@article{arxiv.cond-mat/0011506,
title = {Option Pricing and Hedging with Temporal Correlations},
author = {Lorenzo Cornalba and Jean-Philippe Bouchaud and Marc Potters},
journal= {arXiv preprint arXiv:cond-mat/0011506},
year = {2007}
}
Comments
LaTeX, 15 pp, no figure