Functional Ito Calculus, Path-dependence and the Computation of Greeks

Samy Jazaerli and Yuri F. Saporito ()

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Abstract: Dupire's functional It\^o calculus provides an alternative approach to the classical Malliavin calculus for the computation of sensitivities, also called Greeks, of path-dependent derivatives prices. In this paper, we introduce a measure of path-dependence of functionals within the functional It\^o calculus framework. Namely, we consider the Lie bracket of the space and time functional derivatives, which we use to classify functionals accordingly to their degree of path-dependence. We then revisit the problem of efficient numerical computation of Greeks for path-dependent derivatives using integration by parts techniques. Special attention is paid to path-dependent functionals with zero Lie bracket, called locally weakly path-dependent functionals in our classification. Hence, we derive the weighted-expectation formulas for their Greeks. In the more general case of fully path-dependent functionals, we show that, equipped with the functional It\^o calculus, we are able to analyze the effect of the Lie bracket on the computation of Greeks. Moreover, we are also able to consider the more general dynamics of path-dependent volatility. These were not achieved using Malliavin calculus.

Date: 2013-11, Revised 2018-06
New Economics Papers: this item is included in nep-rmg
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