A Game Theoretic Approach to Robust Option Pricing.ppt

A Game Theoretic Approach to Robust Option Pricing Peter DeMarzo, Stanford Ilan Kremer, Stanford Yishay Mansour, TAU Example 1: Approachability You repeatedly predict the outcome of a coin toss. The coin need not be a fair coin. What success rate can you guarantee in the long run? Simple strategy: Predict Heads with probability 50% and obtain 50% success rate. Learning Strategy: At each point in time guess heads if there were more heads in the past, otherwise guess tails. In the limit the success rate is max{p,1-p} where p is the fixed parameter of the coin. Q: What if the coin can change arbitrarily from period to period? A: You can still get an equivalent performance!! Example 2: Competitive Analysis (Regret Minimization) When you go gambling each minute you choose which slot machine to use. There are N different machines, some machines may be better. You see the payoff of machines even if you did not use them. Goal: In the long run obtain an average payoff that is no worse than the best individual machine ex-post. (No Regret) Q: What if payoffs are not stationary (so a machine which has a high payoff may deteriorate over time)? Regret/Approachability Introduced by Blackwell and Hannan in the late 50s, rediscovered and used in: Computer Science- online algorithms Statistic and Information Theory Game Theory- Calibration, dynamic foundation for Nash/correlated equilibrium With the exception of work on ‘Universal Portfolios’ not incorporated into finance. Regret Minimization Dynamic optimization under uncertainty without a prior. Worst case analysis but specified in relative rather than absolute terms (as in Gilboa and Schmeidler) Insights/Results Minimizing Regret can be expressed as robust upper bound for option pricing. Describe trading strategies that are based on approachability and the bounds/regret they imply for call option with different strike prices. The optimal robust upper bound can be expressed as a value of a zero sum game. Provide a n