Hedging The Risk In The Continuous Time Option Pricing Model With Stochastic Stock Volatility

Details Hedging The Risk In The Continuous Time Option Pricing Model With Stochastic Stock Volatility Hedging The Risk In The Continuous Time Option Pricing Model With Stochastic Stock Volatility

1998-07-04

arxiv.org/abs/cond-mat/9807066v1

Physics

Condensed Matter

Statistical Mechanics

8 pages, Revtex style

Scientific paper

In this work, I address the issue of forming riskless hedge in the continuous time option pricing model with stochastic stock volatility. I show that it is essential to verify whether the replicating portfolio is self-financing, in order for the theory to be self-consistent. The replicating methods in existing finance literature are shown to violate the self-financing constraint when the underlying asset has stochastic volatility. Correct self-financing hedge is formed in this article.

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