Consistent Pricing and Hedging for a Modified Constant Elasticity of Variance Model

David Heath and Eckhard Platen ()

No 78, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: This paper considers a modification of the well-known constant elasticity of variance model where it is used to model the growth optimal portfolio. It is shown taht, for this application, there is no equivalent risk neutral pricing methodology fails. However, a consistent pricing and hedging framework can be established by application of the benchmark approach. Perfect hedging strategies can be constructed for European style contingent claims, where the underlying risky asset is the growth optimal portfolio. In this framework, fair prices for contingent claims are the minimal prices that permit perfect replication of the claims. Numerical examples show that these prices may differ significantly from the corresponding "risk neutral" prices. In cases where these prices are different, arbitrage amounts can be generated.

Keywords: risk neutral pricing; benchmark model; constant elasticity of variance; fair pricing (search for similar items in EconPapers)
JEL-codes: G10 G13 (search for similar items in EconPapers)
Pages: 19 pages
Date: 2002-05-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

Published as: Heath, D. and Platen, E., 2002, "Consistent Pricing and Hedging for a Modified Constant Elasticity of Variance Model", Quantitative Finance, 2(6), 459-467.

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Journal Article: Consistent pricing and hedging for a modified constant elasticity of variance model (2002)
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