Hedging The Risk In The Continuous Time Option Pricing Model With Stochastic Stock Volatility
Abstract
In this work, I address the issue of forming riskless hedge in the continuous time option pricing model with stochastic stock volatility. I show that it is essential to verify whether the replicating portfolio is self-financing, in order for the theory to be self-consistent. The replicating methods in existing finance literature are shown to violate the self-financing constraint when the underlying asset has stochastic volatility. Correct self-financing hedge is formed in this article.
- Publication:
-
arXiv e-prints
- Pub Date:
- July 1998
- DOI:
- 10.48550/arXiv.cond-mat/9807066
- arXiv:
- arXiv:cond-mat/9807066
- Bibcode:
- 1998cond.mat..7066W
- Keywords:
-
- Condensed Matter - Statistical Mechanics;
- Quantitative Finance - Pricing of Securities
- E-Print:
- 8 pages, Revtex style