Static Hedging and Pricing of Exotic Options with Payoff Frames

47 Pages Posted: 13 Mar 2019

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: April 2019

Abstract

We develop a general framework for statically hedging and pricing European‐style options with nonstandard terminal payoffs, which can be applied to mixed static–dynamic and semistatic hedges for many path‐dependent exotic options including variance swaps and barrier options. The goal is achieved by separating the hedging and pricing problems to obtain replicating strategies. Once prices have been obtained for a set of basis payoffs, the pricing and hedging of financial securities with arbitrary payoff 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: basis, exotic hedging, Lévy, option pricing, static hedging, variance swap

Suggested Citation

Kirkby, Justin and Deng, Shijie, Static Hedging and Pricing of Exotic Options with Payoff Frames (April 2019). Mathematical Finance, Vol. 29, Issue 2, pp. 612-658, 2019. Available at SSRN: https://ssrn.com/abstract=3352080 or http://dx.doi.org/10.1111/mafi.12184

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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