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An Alternative Approach For Valuing Continuous Cash Flows

In: Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume III)

Author

Listed:
  • PETER CARR

    (Banc of America Securities, 9 West 57th Street, 40th floor, New York, NY 10019, USA)

  • ALEX LIPTON

    (Deutsche Bank, 31 West 52nd Street, New York, NY 10019, USA)

  • DILIP MADAN

    (University of Maryland, Robert H. Smith School of Business, College Park, MD 20742, USA)

Abstract

We consider the problem of replicating the payoffs from variable annuities with a continuous cash flow given by a function of some traded asset's price. The standard approaches involve either dynamic trading in this underlying asset or a static position in a continuum of options of all strikes and maturities. We present an alternative approach which combines dynamic trading in the underlying asset with a static position in options of a single maturity. In many instances, our approach yields explicit valuation formulas and hedging strategies when the volatility of the underlying is an arbitrary function of its price.

Suggested Citation

  • Peter Carr & Alex Lipton & Dilip Madan, 2002. "An Alternative Approach For Valuing Continuous Cash Flows," World Scientific Book Chapters, in: Marco Avellaneda (ed.), Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume III), chapter 5, pages 110-130, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789812778451_0005
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    Keywords

    Quantitative Analysis; Financial Markets;

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