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The minimal entropy measure and an Esscher transform in an incomplete market model

By Michael Monoyios


We consider an incomplete market model with one traded stock and two correlated Brownian motions $W$,$\widetilde{W}$. The Brownian motion $W$ drives the stock price, whose volatility and Sharpe ratio are adapted to the filtration $\mathbb{F} := (\widetilde{\mathcal{F}}_{t})_{0 \le t \le T}$ generated by $\widetilde{W}$. We show that the projections of the minimal entropy and minimal martingale measures onto $\widetilde{\mathcal{F}}_{T}$ are related by an Esscher transform involving the correlation between $W$,$\widetilde{W}$, and the mean-variance trade-off process. The result leads to a new formula for the marginal exponential utility-based price of an $\widetilde{\mathcal{F}}_{T}$-measurable European claim

Topics: Probability theory and stochastic processes
Year: 2007
DOI identifier: 10.1016/j.spl.2007.01.008
OAI identifier:

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