4.3 Article

Adapted Wasserstein distances and stability in mathematical finance

Journal

FINANCE AND STOCHASTICS
Volume 24, Issue 3, Pages 601-632

Publisher

SPRINGER HEIDELBERG
DOI: 10.1007/s00780-020-00426-3

Keywords

Hedging; Utility maximisation; Optimal transport; Causal optimal transport; Wasserstein distance; Sensitivity; Stability

Funding

  1. FWF [Y782]
  2. Vienna University of Technology - Austrian Science Fund (FWF) [P28661]
  3. Austrian Science Fund (FWF) [Y782] Funding Source: Austrian Science Fund (FWF)

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Assume that an agent models a financial asset through a measure DOUBLE-STRUCK CAPITAL Q with the goal to price/hedge some derivative or optimise some expected utility. Even if the model DOUBLE-STRUCK CAPITAL Q is chosen in the most skilful and sophisticated way, the agent is left with the possibility that DOUBLE-STRUCK CAPITAL Q does not provide an exact description of reality. This leads us to the following question: will the hedge still be somewhat meaningful for models in the proximity of DOUBLE-STRUCK CAPITAL Q? If we measure proximity with the usual Wasserstein distance (say), the answer is No. Models which are similar with respect to the Wasserstein distance may provide dramatically different information on which to base a hedging strategy. Remarkably, this can be overcome by considering a suitable adapted version of the Wasserstein distance which takes the temporal structure of pricing models into account. This adapted Wasserstein distance is most closely related to the nested distance as pioneered by Pflug and Pichler (SIAM J. Optim. 20:1406-1420, 2009, SIAM J. Optim. 22:1-23, 2012, Multistage Stochastic Optimization, 2014). It allows us to establish Lipschitz properties of hedging strategies for semimartingale models in discrete and continuous time. Notably, these abstract results are sharp already for Brownian motion and European call options.

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