Gamma Hedging and Rough Paths

John Armstrong and Andrei Ionescu

Papers from arXiv.org

Abstract: We apply rough-path theory to study the discrete-time gamma-hedging strategy. We show that if a trader knows that the market price of a set of European options will be given by a diffusive pricing model, then the discrete-time gamma-hedging strategy will enable them to replicate other European options so long as the underlying pricing signal is sufficiently regular. This is a sure result and does not require that the underlying pricing signal has a quadratic variation corresponding to a probabilisitic pricing model. We show how to generalise this result to exotic derivatives when the gamma is defined to be the Gubinelli derivative of the delta by deriving rough-path versions of the Clark--Ocone formula which hold surely. We illustrate our theory by proving that if the stock price process is sufficiently regular, as is the implied volatility process of a European derivative with maturity $T$ and smooth payoff $f(S_T)$ satisfying $f^{\prime \prime}>0$, one can replicate with certainty any European derivative with smooth payoff and maturity $T$.

Date: 2023-09, Revised 2024-03
New Economics Papers: this item is included in nep-rmg
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