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Martingale optimal transport in the discrete case via simple linear programming techniques

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Listed:
  • Nicole Bäuerle

    (Karlsruhe Institute of Technology (KIT))

  • Daniel Schmithals

    (Karlsruhe Institute of Technology (KIT))

Abstract

We consider the problem of finding consistent upper price bounds and super replication strategies for exotic options, given the observation of call prices in the market. This field of research is called model-independent finance and has been introduced by Hobson (Finance Stoch 2(4):329–347, 1998). Here we use the link to mass transport problems. In contrast to existing literature we assume that the marginal distributions at the two time points we consider are discrete probability distributions. This has the advantage that the optimization problems reduce to linear programs and can be solved rather easily when assuming a general martingale Spence Mirrlees condition. We will prove the optimality of left-monotone transport plans under this assumption and provide an algorithm for its construction. Our proofs are simple and do not require much knowledge of probability theory. At the end we present an example to illustrate our approach.

Suggested Citation

  • Nicole Bäuerle & Daniel Schmithals, 2019. "Martingale optimal transport in the discrete case via simple linear programming techniques," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 90(3), pages 453-476, December.
    • Handle: RePEc:spr:mathme:v:90:y:2019:i:3:d:10.1007_s00186-019-00684-8
    DOI: 10.1007/s00186-019-00684-8
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    References listed on IDEAS

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    1. Beiglböck, Mathias & Henry-Labordère, Pierre & Touzi, Nizar, 2017. "Monotone martingale transport plans and Skorokhod embedding," Stochastic Processes and their Applications, Elsevier, vol. 127(9), pages 3005-3013.
    2. Breeden, Douglas T & Litzenberger, Robert H, 1978. "Prices of State-contingent Claims Implicit in Option Prices," The Journal of Business, University of Chicago Press, vol. 51(4), pages 621-651, October.
    3. Huesmann, Martin & Stebegg, Florian, 2018. "Monotonicity preserving transformations of MOT and SEP," Stochastic Processes and their Applications, Elsevier, vol. 128(4), pages 1114-1134.
    4. Mathias Beiglbock & Pierre Henry-Labord`ere & Friedrich Penkner, 2011. "Model-independent Bounds for Option Prices: A Mass Transport Approach," Papers 1106.5929, arXiv.org, revised Feb 2013.
    5. Mathias Beiglboeck & Pierre Henry-Labordere & Nizar Touzi, 2017. "Monotone Martingale Transport Plans and Skorohod Embedding," Papers 1701.06779, arXiv.org.
    6. Pierre Henry-Labordère & Nizar Touzi, 2016. "An explicit martingale version of the one-dimensional Brenier theorem," Finance and Stochastics, Springer, vol. 20(3), pages 635-668, July.
    7. David G. Hobson, 1998. "Robust hedging of the lookback option," Finance and Stochastics, Springer, vol. 2(4), pages 329-347.
    8. Marcel Nutz & Florian Stebegg & Xiaowei Tan, 2017. "Multiperiod Martingale Transport," Papers 1703.10588, arXiv.org, revised May 2019.
    9. Henry-Labordère, Pierre & Tan, Xiaolu & Touzi, Nizar, 2016. "An explicit martingale version of the one-dimensional Brenier’s Theorem with full marginals constraint," Stochastic Processes and their Applications, Elsevier, vol. 126(9), pages 2800-2834.
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