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The Economic Research Institute, Stockholm School of Economics SSE/EFI Working Paper Series in Economics and Finance

No 596:
A Note on Wick Products and the Fractional Black-Scholes Model

Tomas Björk () and Henrik Hult ()

Abstract: In some recent papers, such as Elliott & van der Hoek, Hu & Öksendal, a fractional Black-Scholes model have been proposed as an improvement of the classical Black-Scholes model. Common to these fractional Black-Scholes models, is that the driving Brownian motion is replaced by a fractional Brownian motion and that the Ito integral is replaced by the Wick integral, and proofs has been presented that these fractional Black-Scholes models are free of arbitrage. These results on absence of arbitrage complelety contradict a number of earlier results in the literature which prove that the fractional Black-Scholes model (and related models) will in fact admit arbitrage.

The object of the present paper is to resolve this contradiction by pointing out that the definition of the self-financing trading strategies and/or the definition of the value of a portfolio used in the above cited papers does not have a reasonable economic interpretation, and thus that the results in these papers are not economically meaningful. In particular we show that in the framework of Elliott and van der Hoek, a naive buy-and-hold strategy does not in general qualify as "self-financing". We also show that in Hu and Öksendal, a portfolio consisting of a positive number of shares of a stock with a positive price may, with positive probability, have a negative "value".

Keywords: Mathematical Finance; Fractional Brownian motion; Arbitrage; option; financial derivatives; wick; (follow links to similar papers)

JEL-Codes: G10; (follow links to similar papers)

13 pages, April 25, 2005

Published in: "Finance and Stochastics", Vol 9, No 2, pp 197-209, (2005).

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This paper is published as:
Björk, Tomas and Henrik Hult, (2005), 'A Note on Wick Products and the Fractional Black-Scholes Model', Finance & Stochastics, Vol. 9, No. 2, pages 197-209

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