Real-world options: smile and residual risk

Details Real-world options: smile and residual risk Real-world options: smile and residual risk

1995-09-15

arxiv.org/abs/cond-mat/9509095v2

Risk 9 3, 61-65, March 1996

Physics

Condensed Matter

11 pages,Latex, 5 figures (appended as uuencoded compressed tar -file)

Scientific paper

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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