Explicit Representation of Cost-Efficient Strategies

Carole Bernard, Phelim P. Boyle and Steven Vanduffel ()

Finance, 2014, vol. 35, issue 2, 5-55

Abstract: In this paper, we give an explicit representation of the lowest cost strategy to achieve a given payoff distribution (that we call ?cost-efficient? strategy). For any inefficient strategy, we are able to construct financial derivatives which dominate in the sense of first-order or second-order stochastic dominance. We highlight the connections between cost-efficiency and dependence. This allows us to extend the theory to deal with state-dependent constraints to better reflect real-world preferences. We show in particular that path-dependent strategies (although inefficient in the Black Scholes setting) may become optimal in the presence of state-dependent constraints.

Date: 2014
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Citations: View citations in EconPapers (22)

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