Risk-return arguments applied to options with trading costs

We study the problem of option pricing and hedging strategies within the frame-work of risk-return arguments. An economic agent is described by a utility function that depends on profit (an expected value) and risk (a variance). In the ideal case without transaction costs the optimal strategy for any given agent is found as the explicit solution of a constrained optimization problem. Transaction costs are taken into account on a perturbative way. A rational option price, in a world with only these agents, is then determined by considering the points of view of the buyer and the writer of the option. Price and strategy are determined to first order in the transaction costs.Comment: 10 pages, in LaTeX, no figures, Paper to be published in the Proceedings of the conference "Disorder and Chaos", in memory of Giovanni Paladin, Rome, Italy, 22-24 September 199

Self-gravitating systems in a three-dimensional expanding Universe

The non-linear evolution of one-dimensional perturbations in a three-dimensional expanding Universe is considered. A general Lagrangian scheme is derived, and compared to two previously introduced approximate models. These models are simulated with heap-based event-driven numerical procedure, that allows for the study of large systems, averaged over many realizations of random initial conditions. One of the models is shown to be qualitatively, and, in some respects, concerning mass aggregation, quantitatively similar to the adhesion model.Comment: 11 figures, simulations of Q model include

Perturbative large deviation analysis of non-equilibrium dynamics

Macroscopic fluctuation theory has shown that a wide class of non-equilibrium stochastic dynamical systems obey a large deviation principle, but except for a few one-dimensional examples these large deviation principles are in general not known in closed form. We consider the problem of constructing successive approximations to an (unknown) large deviation functional and show that the non-equilibrium probability distribution the takes a Gibbs-Boltzmann form with a set of auxiliary (non-physical) energy functions. The expectation values of these auxiliary energy functions and their conjugate quantities satisfy a closed system of equations which can imply a considerable reduction of dimensionality of the dynamics. We show that the accuracy of the approximations can be tested self-consistently without solving the full non- equilibrium equations. We test the general procedure on the simple model problem of a relaxing 1D Ising chain.Comment: 21 pages, 10 figure

An inventory of Lattice Boltzmann models of multiphase flows

This document reports investigations of models of multiphase flows using Lattice Boltzmann methods. The emphasis is on deriving by Chapman-Enskog techniques the corresponding macroscopic equations. The singular interface (Young-Laplace-Gauss) model is described briefly, with a discussion of its limitations. The diffuse interface theory is discussed in more detail, and shown to lead to the singular interface model in the proper asymptotic limit. The Lattice Boltzmann method is presented in its simplest form appropriate for an ideal gas. Four different Lattice Boltzmann models for non-ideal (multi-phase) isothermal flows are then presented in detail, and the resulting macroscopic equations derived. Partly in contradiction with the published literature, it is found that only one of the models gives physically fully acceptable equations. The form of the equation of state for a multiphase system in the density interval above the coexistance line determines surface tension and interface thickness in the diffuse interface theory. The use of this relation for optimizing a numerical model is discussed. The extension of Lattice Boltzmann methods to the non-isothermal situation is discussed summarily.Comment: 59 pages, 5 figure

Financial Friction and Multiplicative Markov Market Game

We study long-term growth-optimal strategies on a simple market with linear proportional transaction costs. We show that several problems of this sort can be solved in closed form, and explicit the non-analytic dependance of optimal strategies and expected frictional losses of the friction parameter. We present one derivation in terms of invariant measures of drift-diffusion processes (Fokker- Planck approach), and one derivation using the Hamilton-Jacobi-Bellman equation of optimal control theory. We also show that a significant part of the results can be derived without computation by a kind of dimensional analysis. We comment on the extension of the method to other sources of uncertainty, and discuss what conclusions can be drawn about the growth-optimal criterion as such.Comment: 10 pages, invited talk at the European Physical Society conference 'Applications of Physics in Financial Analysis', Trinity College, Dublin, Ireland, July 14-17, 199