Pricing and hedging for a sticky diffusion

Abstract

We introduce a financial market model featuring a risky asset whose price follows a sticky geometric Brownian motion and a riskless asset that grows with a constant interest rate $r\in \mathbb{R}$. We prove that this model satisfies No Arbitrage (NA) and No Free Lunch with Vanishing Risk (NFLVR) only when $r=0$. Under this condition, we derive the corresponding arbitrage-free pricing equation, assess replicability and representation of the replication strategy. We then show that all locally bounded replicable payoffs for the standard Black--Scholes model are also replicable for the sticky model. Last, we evaluate via numerical experiments the impact of hedging in discrete time and of misrepresenting price stickiness.

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• Sticky Brownian Motion and its Numerical Solution
• Steady states in a structured epidemic model with Wentzell boundary condition
• General diffusion processes as the limit of time-space Markov chains
• Functional convergence to the local time of a sticky diffusion
• Separating Times for One-Dimensional General Diffusions