Computing deltas without derivatives

D. Baños (), T. Meyer-Brandis (), F. Proske () and S. Duedahl ()
Additional contact information
D. Baños: University of Oslo
T. Meyer-Brandis: University of Munich
F. Proske: University of Oslo
S. Duedahl: University of Oslo

Finance and Stochastics, 2017, vol. 21, issue 2, No 7, 509-549

Abstract: Abstract A well-known application of Malliavin calculus in mathematical finance is the probabilistic representation of option price sensitivities, the so-called Greeks, as expectation functionals that do not involve the derivative of the payoff function. This allows numerically tractable computation of the Greeks even for discontinuous payoff functions. However, while the payoff function is allowed to be irregular, the coefficients of the underlying diffusion are required to be smooth in the existing literature, which for example already excludes simple regime-switching diffusion models. The aim of this article is to generalise this application of Malliavin calculus to Itô diffusions with irregular drift coefficients, where we focus here on the computation of the delta, which is the option price sensitivity with respect to the initial value of the underlying. To this end, we first show existence, Malliavin differentiability and (Sobolev) differentiability in the initial condition for strong solutions of Itô diffusions with drift coefficients that can be decomposed into the sum of a bounded, but merely measurable, and a Lipschitz part. Furthermore, we give explicit expressions for the corresponding Malliavin and Sobolev derivatives in terms of the local time of the diffusion, respectively. We then turn to the main objective of this article and analyse the existence and probabilistic representation of the corresponding deltas for European and path-dependent options. We conclude with a small simulation study of several regime-switching examples.

Keywords: Greeks; Delta; Option sensitivities; Malliavin calculus; Bismut–Elworthy–Li formula; Irregular diffusion coefficients; Strong solutions of stochastic differential equations; Relative L 2 $L^{2}$ -compactness; 60H10; 60H07; 60H30; 91G60 (search for similar items in EconPapers)
JEL-codes: C02 C63 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s00780-016-0321-3

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