English

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