2021/03/17 by Mine Çağlar, Mine Caglar, Caglar, Mine +6
Economics, Econometrics and Finance · Mathematics · #60H07 #91G30 #Differential Equations and Numerical Methods #FOS: Mathematics #Financial Risk and Volatility Modeling #Probability (math.PR) #Stochastic processes and financial applications #math.PR #msc:60H07 #msc:91G30
paper · pdf · doi:10.48550/arxiv.2103.09770
openalex publication_date 2021/03/17 · arxiv created 2021/03/18 · arxiv updated 2021/03/19 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28
We consider a semimartingale market model when the underlying diffusion has a singular volatility matrix and compute the hedging portfolio for a given payoff function. Recently, the representation problem for such degenerate diffusions with respect to a minimal martingale has been completely settled. This martingale representation and Malliavin calculus established further for the functionals of a degenerate diffusion process constitute the basis of the present work. Using the Clark-Hausmann-Bismut-Ocone type representation formula derived for these functionals, we prove a version of this formula under an equivalent martingale measure. This allows us to derive the hedging portfolio as a solution of a system of linear equations. The uniqueness of the solution is achieved by a projection idea that lies at the core of the martingale representation at the first place. We demonstrate the hedging strategy as explicitly as possible with some examples of the payoff function such as those used in exotic options, whose value at maturity depends on the prices over the entire time horizon.