AN ALTERNATIVE APPROACH FOR VALUING CONTINUOUS CASH FLOWS

Peter Carr, Alex Lipton and Dilip Madan
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Alex Lipton: Deutsche Bank, 31 West 52nd Street, New York, NY 10019, USA
Dilip Madan: University of Maryland, Robert H. Smith School of Business, College Park, MD 20742, USA

Chapter 5 in Quantitative Analysis in Financial Markets:Collected Papers of the New York University Mathematical Finance Seminar(Volume III), 2002, pp 110-130 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractWe consider the problem of replicating the payoffs from variable annuities with a continuous cash flow given by a function of some traded asset's price. The standard approaches involve either dynamic trading in this underlying asset or a static position in a continuum of options of all strikes and maturities. We present an alternative approach which combines dynamic trading in the underlying asset with a static position in options of a single maturity. In many instances, our approach yields explicit valuation formulas and hedging strategies when the volatility of the underlying is an arbitrary function of its price.

Keywords: Quantitative Analysis; Financial Markets (search for similar items in EconPapers)
Date: 2002
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