Explicit Representation of Cost-Efficient Strategies

39 Pages Posted: 30 Jul 2010 Last revised: 18 Apr 2013

Carole Bernard

Grenoble Ecole de Management

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics; University of Waterloo

Steven Vanduffel

Vrije Universiteit Brussel (VUB)

Multiple version iconThere are 2 versions of this paper

Date Written: April 17, 2013

Abstract

In this paper, we give an explicit representation of the lowest cost strategy (or "cost-efficient" strategy) to achieve a given payoff distribution. For any inefficient strategy, we are able to construct financial derivatives which dominate in the sense of first-order or second-order stochastic dominance. We highlight the connections between cost-efficiency and dependence (copulas). This allows us to extend the theory to deal with state-dependent constraints to better reflect real world preferences. We show in particular that path-dependent strategies (although inefficient in the Black Scholes setting) may become optimal in the presence of state-dependent constraints.

Keywords: Law-invariant increasing preferences, Stochastic Dominance, Expected Utility, State-dependent preferences, Copulas

JEL Classification: D81, D91, G11, G12, G13

Suggested Citation

Bernard, Carole and Boyle, Phelim P. and Vanduffel, Steven, Explicit Representation of Cost-Efficient Strategies (April 17, 2013). Available at SSRN: https://ssrn.com/abstract=1561272 or http://dx.doi.org/10.2139/ssrn.1561272

Carole Bernard (Contact Author)

Grenoble Ecole de Management ( email )

12, rue Pierre Sémard
Grenoble Cedex, 38003
France

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada
519 884 1970 (Phone)
519 888 1015 (Fax)

University of Waterloo

Waterloo, Ontario N2L 3G1
Canada

Steven Vanduffel

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
Brussels, Brabant 1050
Belgium

HOME PAGE: http://www.stevenvanduffel.com

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