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On the hedging of options on exploding exchange rates

Carrol, Peter and Fisher, Travis and Ruf, Johannes (2013) On the hedging of options on exploding exchange rates. Finance and Stochastics, 18 (1). pp. 115-144. ISSN 0949-2984

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Identification Number: 10.1007/s00780-013-0218-3

Abstract

We study a novel pricing operator for complete, local martingale models. The new pricing operator guarantees put-call parity to hold for model prices and the value of a forward contract to match the buy-and-hold strategy, even if the underlying follows strict local martingale dynamics. More precisely, we discuss a change of numéraire (change of currency) technique when the underlying is only a local martingale, modelling for example an exchange rate. The new pricing operator assigns prices to contingent claims according to the minimal cost for superreplication strategies that succeed with probability one for both currencies as numéraire. Within this context, we interpret the lack of the martingale property of an exchange rate as a reflection of the possibility that the numéraire currency may devalue completely against the asset currency (hyperinflation).

Item Type: Article
Official URL: https://link.springer.com/journal/780
Additional Information: © 2013 Springer
Divisions: Mathematics
Subjects: Q Science > QA Mathematics
Sets: Departments > Mathematics
Date Deposited: 11 Oct 2017 11:35
Last Modified: 11 Oct 2017 11:35
URI: http://eprints.lse.ac.uk/id/eprint/84587

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