Real-world options: smile and residual risk

1 January 1994

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We present a theory of option pricing and hedging, designed to address non-perfect arbitrage, market friction and the presence of 'fat' tails. An implied volatility 'smile' is predicted. We give precise estimates of the residual risk associated with optimal (but imperfect) hedging.

Authors

Giulia Iori , Didier Sornette , Jean-Philippe Bouchaud