Benchmarking and Fair Pricing Applied to Two Market Models

Hardy Hulley, Shane Miller and Eckhard Platen ()
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Shane Miller: School of Finance and Economics, University of Technology, Sydney, http://www.business.uts.edu.au/finance/

No 155, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: This paper considers a market containing both continuous and discrete noise. Modest assumptions ensure the existence of a growth optimal portfolio. Non-negative self-financing trading strategies, when benchmarked by this portfolio, are local martingales under the real-world measure. This justifies the fair pricing approach, which expresses derivative prices in terms of real-world conditional expectations of benchmarked payoffs. Two models for benchmarked primary security accounts are presented, and fair pricing formulas for some common contingent claims are derived.

Keywords: growth optimal portfolio; benchmark approach; fair pricing; Merton model; minimal market model (search for similar items in EconPapers)
JEL-codes: G10 G13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin
Date: 2005-03-01
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