Pricing and hedging in the presence of extraneous risks |
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Authors: | Pierre Collin Dufresne Julien Hugonnier |
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Affiliation: | 1. Haas School of Business, University of California Berkeley, 545 Students Services Building, Berkeley, CA 94720, USA;2. Swiss Finance Institute and HEC Université de Lausanne, Lausanne 1007, Switzerland |
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Abstract: | Given an underlying complete financial market, we study contingent claims whose payoffs may depend on the occurrence of nonmarket events. We first investigate the almost-sure hedging of such claims. In particular, we obtain new representations of the hedging prices and provide necessary and sufficient conditions for a claim to be marketed. The analysis of various examples then leads us to investigate alternative pricing rules. We choose to embed the pricing problem into the agent’s portfolio decision and study reservation prices. We establish the existence and consistency of this pricing rule in a semimartingale model. We characterize the nonlinear dependence of the reservation price with respect to both the agent’s initial capital and the size of her position. The fair price arises as a limiting case. |
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Keywords: | 60H30 91B38 93E20 |
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