Portfolios Generated by Contingent Claim Functions, with Applications to Option Pricing

Ricardo Fernholz and Robert Fernholz

Papers from arXiv.org

Abstract: This paper is a synthesis of the theories of portfolio generating functions and rational option pricing. For a family of n >= 2 assets with prices represented by strictly positive continuous semimartingales, a contingent claim function is a scalable positive C^{2,1} function of the asset prices and time. We extend the theory of portfolio generation to measure the value of portfolios generated by contingent claim functions directly, with no numeraire portfolio. We show that if a contingent claim function satisfies a particular parabolic differential equation, then the value of the portfolio generated by that contingent claim function will replicate the value of the function. This differential equation is a general form of the Black-Scholes equation.

Date: 2023-08, Revised 2024-01
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