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arxiv: cond-mat/0011506 · v1 · submitted 2000-11-29 · ❄️ cond-mat

Option Pricing and Hedging with Temporal Correlations

classification ❄️ cond-mat
keywords correlationsblack-scholescorrelatedformulahedgingincrementsnon-gaussianoption
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We consider the problem of option pricing and hedging when stock returns are correlated in time. Within a quadratic-risk minimisation scheme, we obtain a general formula, valid for weakly correlated non-Gaussian processes. We show that for Gaussian price increments, the correlations are irrelevant, and the Black-Scholes formula holds with the volatility of the price increments on the scale of the re-hedging. For non-Gaussian processes, further non trivial corrections to the `smile' are brought about by the correlations, even when the hedge is the Black-Scholes Delta-hedge. We introduce a compact notation which eases the computations and could be of use to deal with more complicated models.

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