Maximum Maximum of Martingales Given Marginals
Société Générale - Paris, France
University of Oxford - Mathematical Institute; University of Oxford - Oxford-Man Institute of Quantitative Finance; University of Oxford - Saint John's College
University of Oxford
Ecole Polytechnique, Paris
We consider the problem of superhedging under volatility uncertainty for an investor allowed to dynamically trade the underlying asset and statically trade European call options for all possible strikes and finitely-many maturities. We present a general duality result which converts this problem into a min-max calculus of variations problem where the Lagrange multipliers correspond to the static part of the hedge. Following Galichon, Henry-Labord\`ere and Touzi, we apply stochastic control methods to solve it explicitly for Lookback options with a non-decreasing payoff function. The first step of our solution recovers the extended optimal properties of the Az\'ema-Yor solution of the Skorokhod embedding problem obtained by Hobson and Klimmek (under slightly different conditions). The two marginal case corresponds to the work of Brown, Hobson and Rogers.
The robust superhedging cost is complemented by (simple) dynamic trading and leads to a class of semi-static trading strategies. The superhedging property then reduces to a functional inequality which we verify independently. The optimality follows from existence of a model which achieves equality which is obtained in Ob\l\'oj and Spoida.
Number of Pages in PDF File: 35
Keywords: Optimal control, robust pricing and hedging, volatility uncertainty, optimal transportation, pathwise inequalities, lookback option
JEL Classification: C00
Date posted: April 1, 2012 ; Last revised: April 10, 2013