Option Pricing in Fractional Brownian Markets by Stefan Rostek

By Stefan Rostek

The medical debate of contemporary years approximately choice pricing with recognize to fractional Brownian movement used to be all in favour of the feasibility of the no arbitrage pricing procedure. because the unrestricted fractional industry surroundings allows arbitrage, the traditional reasoning is that fractional Brownian movement doesn't qualify for modeling expense process.

In this e-book, the writer issues out that arbitrage can basically be excluded in case that marketplace costs circulate at the least a little speedier than any marketplace player can react. He clarifies that non-stop tradability continuously gets rid of the danger of the fractional cost approach, without reference to the translation of the stochastic necessary as an essential of Stratonovich or Itô type.

Being left with an incomplete marketplace surroundings, the writer exhibits that choice valuation with appreciate to fractional Brownian movement might be solved by means of making use of a danger choice established method. The latter offers us with an intuitive closed-form resolution for ecu concepts in the fractional context.

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The conditional tree for Hurst parameters H < 12 now shows a convex or dispersing envelope, whereas the parameters larger than one half standing for persistence yield a concave or contracting shape of the conditional tree. Though this seems to contradict the explanations given in the preceding section, this is actually not the case at all. To see why, we have to interpret the meaning of one path within the conditional tree which is nothing but the random evolution of the prediction for the terminal value.

Note that this property is not given within the unconditional tree, where all the historic ups and downs have to be rescaled by new coefficients. 75 1 Fig. 75 1 Fig. 2 Binomial Approximation of the Conditional Moments of FBM 43 the appropriate second moments. We hence look at the conditional variance defined by 2 σ ˆT,t =E H ˆT,t |Ft BTH − B 2 . Transforming this to our binomial model means measuring the deviations of the terminal nodes BTH around the time t node of the conditional tree. For a sufficiently large number of discretization steps, the results we obtain approximately equal the theoretical values of the according continuous time setting (for a derivation of the continuous time reference values, see Sect.

For a summarizing discussion of the topic, see Bender (2003a). 26 2 Fractional Integration Calculus The classical Girsanov theorem discusses the properties of classical Brownian motion—or more generally classical Brownian integrals—under change of measure. It gives the possibility of changing a Brownian motion with drift into one without any drift. The same is possible in the fractional context. Norros and Valkeila (1999) p. 4) then, there is a suitable measure P a so that Xt ∼ = BtH P a, under that is, Xt is a fractional Brownian motion without drift under the new measure.

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