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Bounding Contingent Claim Prices via Hedging Strategy with Coherent Risk Measures

Author

Listed:
  • Jun-ya Gotoh

    (Chuo University)

  • Yoshitsugu Yamamoto

    (University of Tsukuba)

  • Weifeng Yao

    (China Universal Asset Management Co., Ltd)

Abstract

We generalize the notion of arbitrage based on the coherent risk measure, and investigate a mathematical optimization approach for tightening the lower and upper bounds of the price of contingent claims in incomplete markets. Due to the dual representation of coherent risk measures, the lower and upper bounds of price are located by solving a pair of semi-infinite linear optimization problems, which further reduce to linear optimization when conditional value-at-risk (CVaR) is used as risk measure. We also show that the hedging portfolio problem is viewed as a robust optimization problem. Tuning the parameter of the risk measure, we demonstrate by numerical examples that the two bounds approach to each other and converge to a price that is fair in the sense that seller and buyer face the same amount of risk.

Suggested Citation

  • Jun-ya Gotoh & Yoshitsugu Yamamoto & Weifeng Yao, 2011. "Bounding Contingent Claim Prices via Hedging Strategy with Coherent Risk Measures," Journal of Optimization Theory and Applications, Springer, vol. 151(3), pages 613-632, December.
    • Handle: RePEc:spr:joptap:v:151:y:2011:i:3:d:10.1007_s10957-011-9899-y
    DOI: 10.1007/s10957-011-9899-y
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    References listed on IDEAS

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