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Hedging in a discontinuous market: the barrier option and the unlikely profit
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Resumo(s)
In principle, the Black-Scholes equation assumes log-normal underlying prices, but
market dynamics do not empirically fit these assumptions, and the related scale
invariance and continuity properties fail at shorter time spans. The aim of this study is
to analyze how the pricing-hedging model may be adjusted when prices are assumed to
have discontinuous paths resulting in heavy tails distribution of returns. Numerically,
the model seems to work for vanilla contracts but not for exotic options. Some
explanations and alternatives are therefore provided. Finally, a further interesting
question arises from the results achieved: is it possible to smooth the smile effect?
Descrição
A Work Project, presented as part of the requirements for the Award of a Masters Degree in Finance from the NOVA – School of Business and Economics
Palavras-chave
Calibration Volatility smile Monte Carlo simulation Poisson jump