Pricing and hedging for incomplete jump diffusion benchmark models

Abstract

This paper considers a class of incomplete financial market models with security price processes that exhibit intensity based jumps. The benchmark or numeraire is chosen to be the growth optimal portfolio. Portfolio values, when expressed in units of the benchmark, are local martingales. In general, an equivalent risk neutral martingale measure need not exist in the proposed framework. Benchmarked fair derivative prices are defined as conditional expectations of future benchmarked prices under the real world probability measure. This concept of fair pricing generalizes classical risk neutral pricing. The pricing under incompleteness is modeled by the choice of the market prices for risk. The hedging is performed under minimization of profit and loss fluctuations.