Recognition: unknown
Real-world options: smile and residual risk
classification
❄️ cond-mat
keywords
hedgingresidualrisksmileaddressarbitrageassociateddesigned
read the original abstract
We present a theory of option pricing and hedging, designed to address non-perfect arbitrage, market friction and the presence of `fat' tails. An implied volatility `smile' is predicted. We give precise estimates of the residual risk associated with optimal (but imperfect) hedging.
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