A stochastic control approach to no-arbitrage bounds given marginals, with an application to lookback options

Abstract

We consider the problem of superhedging under volatility uncertainty for an investor allowed to dynamically trade the underlying asset, and statically trade European call options for all possible strikes with some given maturity. This problem is classically approached by means of the Skorohod Embedding Problem (SEP). Instead, we provide a dual formulation which converts the superhedging problem into a continuous martingale optimal transportation problem. We then show that this formulation allows us to recover previously known results about lookback options. In particular, our methodology induces a new proof of the optimality of Azéma-Yor solution of the SEP for a certain class of lookback options. Unlike the SEP technique, our approach applies to a large class of exotics and is suitable for numerical approximation techniques.

Published in at http://dx.doi.org/10.1214/13-AAP925 the Annals of Applied Probability (http://www.imstat.org/aap/) by the Institute of Mathematical Statistics (http://www.imstat.org)

References in corpus (3)

• A theoretical framework for the pricing of contingent claims in the presence of model uncertainty
• Optimal transportation under controlled stochastic dynamics
• Pathwise inequalities for local time: Applications to Skorokhod embeddings and optimal stopping

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