A Duality Result for Robust Optimization with Expectation Constraints

Christopher W. Miller

Papers from arXiv.org

Abstract: This paper demonstrates a practical method for computing the solution of an expectation-constrained robust maximization problem with immediate applications to model-free no-arbitrage bounds and super-replication values for many financial derivatives. While the previous literature has connected super-replication values to a convex minimization problem whose objective function is related to a sequence of iterated concave envelopes, we show how this whole process can be encoded in a single convex minimization problem. The natural finite-dimensional approximation of this minimization problem results in an easily-implementable sparse linear program. We highlight this technique by obtaining no-arbitrage bounds on the prices of forward-starting options, continuously-monitored variance swaps, and discretely-monitored gamma swaps, each subject to observed bid-ask spreads of finitely-many vanilla options.

Date: 2016-10
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