Model-independent pricing with insider information: a skorokhod embedding approach

In this paper we consider the pricing and hedging of financial derivatives in a model-independent setting, for a trader with additional information, or beliefs, on the evolution of asset prices. In particular, we suppose that the trader wants to act in a way which is independent of any modelling assumptions, but that she observes market information in the form of the prices of vanilla call options on the asset. We also assume that both the payoff of the derivative, and the insider’s information or beliefs, which take the form of a set of impossible paths, are time-invariant. In this way we accommodate drawdown constraints, as well as information/beliefs on quadratic variation or on the levels hit by asset prices. Our setup allows us to adapt recent work of [12] to prove duality results and a monotonicity principle. This enables us to determine geometric properties of the optimal models. Moreover, for specific types of information, we provide simple conditions for the existence of consistent models for the informed agent. Finally, we provide an example where our framework allows us to compute the impact of the information on the agent’s pricing bounds.

ESTIMATES FOR J-CURVES AS SUBMANIFOLDS

In this paper, we develop some basic analytic tools to study compactness properties of J-curves (i.e. pseudoholomorphic curves) when regarded as submanifolds. Incorporating techniques from the theory of minimal surfaces, we derive an inhomogeneous mean curvature equation for such curves by establishing an extrinsic monotonicity principle for nonnegative functions f satisfying Δf ≥ -c2f, we show that curves locally parametrized as a graph over a coordinate tangent plane have all derivatives a priori bounded in terms of curvature and ambient geometry, and we thus establish ϵ-regularity for the square length of their second fundamental forms. These results are all provided for J-curves either with or without Lagrangian boundary and hold in almost all Hermitian manifolds of arbitrary even dimension (i.e. Riemannian manifolds for which the almost complex structure is an isometry).

BELIEF-REVISION, THE RAMSEY TEST, MONOTONICITY, AND THE SO-CALLED IMPOSSIBILITY RESULTS

Peter Gärdenfors proved a theorem purporting to show that it is impossible to adjoin to the AGM-postulates for belief-revision a principle of monotonicity for revisions. The principle of monotonicity in question is implied by the Ramsey test for conditionals. So Gärdenfors’ result has been interpreted as demonstrating that it is impossible to combine the Ramsey test for conditionals with the basic postulates for rational belief-revision. It is shown here that this interpretation of Gärdenfors’ result is unwarranted. A new diagnosis is offered of a methodological error made in the statement of the key principle of monotonicity. Crucial applications of this principle in Gärdenfors’ proof require one to regard as revisions what are really expansions. If monotonicity is stated only for genuine revisions, then Gärdenfors’ proof does not go through. Nor can it; for, when the monotonicity principle for revisions is correctly formulated, one can actually establish a contrary consistency result. This requires only a slight adjustment to the postulates of AGM-theory, in order to ensure that the three operations of expansion, contraction, and revision trichotomize the domain of theory-changes. It is further shown that being careful in this way about the proper domains of definition of the three operations of expansion, contraction, and revision also disposes of another, more direct, impossibility result, due to Arló-Costa, that targets the Ramsey test.

4. Reasoning with Partial Knowledge

We investigate how sociological argumentation differs from classical first-order logic. We focus on theories about age dependence of organizational mortality. The overall pattern of argument does not comply with the classical monotonicity principle: Adding premises overturns conclusions in an argument. The cause of nonmonotonicity is the need to derive conclusions from partial knowledge. We identify metaprinciples that appear to guide the observed sociological argumentation patterns, and we formalize a semantics to represent them. This semantics yields a new kind of logical consequence relation. We demonstrate that this new logic can reproduce the results of informal sociological theorizing and lead to new insights. It allows us to unify existing theory fragments, and it paves the way toward a complete classical theory. Observed inferential patterns which seem “wrong” according to one notion of inference might just as well signal that the speaker is engaged in correct execution of another style of reasoning. —Johan van Benthem (1996)