Static Hedging and Pricing of Exotic Options with Payoff Frames

Mathematical Finance, Forthcoming

44 Pages Posted: 27 Sep 2014 Last revised: 19 Mar 2018

See all articles by Justin Kirkby

Justin Kirkby

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE)

Shijie Deng

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE)

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Date Written: September 25, 2017

Abstract

We develop a general framework for statically hedging European-style options with nonstandard terminal payoffs which can be applied to mixed static-dynamic and semi-static hedges for many path dependent exotic options. This framework provides a new model-free method of derivatives pricing that builds on recent advances in transform-based numerical approaches. The goal is achieved by separating the hedging and pricing problems to obtain model-free replicating strategies. Once prices have been obtained for a set of basis payoffs, the pricing and hedging of financial securities with arbitrary payoffs functions is accomplished by computing a set of "hedge coefficients" for that security. This method is particularly well suited for pricing baskets of options simultaneously, and is robust to discontinuities of payoffs. In addition, the method enables a systematic comparison of the value of a payoff (or portfolio) across a set of competing model specifications with implications for security design.

Keywords: Option pricing, static hedging, exotic options, projection, basis, frame, replication, European options, semi-static, derivatives, calibration

Suggested Citation

Kirkby, Justin and Deng, Shijie, Static Hedging and Pricing of Exotic Options with Payoff Frames (September 25, 2017). Mathematical Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2501812 or http://dx.doi.org/10.2139/ssrn.2501812

Justin Kirkby (Contact Author)

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE) ( email )

765 Ferst Drive
Atlanta, GA 30332-0205
United States

Shijie Deng

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE) ( email )

765 Ferst Drive
Atlanta, GA 30332-0205
United States

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