On hedging in finite security markets

Silvia Florio and Wolfgang Runggaldier

Applied Mathematical Finance, 1999, vol. 6, issue 3, 159-176

Abstract: A market is considered where trading can take place only at discrete time points, the trading frequency cannot grow without bound, and the number of states of nature is finite. The main objectives of the paper are to show that the market can be completed also with highly correlated risky assets, and to describe an efficient algorithm to compute a self-financing hedging strategy. The algorithm consists off-line of a backwards recursion and on-line of the solution, in each period, of a system of linear equations; it is a consequence of a proof where, using a well-known mathematical property, it is shown that uniqueness of the martingale measure implies completeness also in our setting. The significance of 'multistate' models versus the familiar binomial model is discussed and it is shown how the evolution of prices of the (correlated) risky assets can be chosen so that a given probability measure is already the unique equivalent martingale measure.

Keywords: Finite Security Markets; Discrete Time Trading; Equivalent Martingale Measures; Market Completion; Self-financing Hedging Strategies (search for similar items in EconPapers)
Date: 1999
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DOI: 10.1080/135048699334519

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