Hi edenisaac I am interested in the issueof your post although unfortunately I can not help you at that time. Can you provide me some insight, articles, ... on how may I set up the two models you mention? Thanks

Thanks bwarren I will look for Heston model.Thanks double trouble, the key point however I think is whether the market for S^3 is complete, or in other words, if every positive S^3_t is replicable.

In this simple case it is possible to suppose the price equals the payoff isn't? Regarding volatility, can you suggest an stochastic model? Thanks.

<t>Thanks for the answer but I do not get your point. The value of the option is S^3 or exp(-rt)S^3 if european. And the delta is the first derivative of the option vs underlying, in this case 3S^2 or exp(-rt)3S^2 for the european one. I do not see how to hedge this by only holding the underlying an...

For an option that just pays the third power of the underlying, payoff = S^3, delta would be 3S^2, which I think can not be replicated holding underlying stock and risk free rate.

May be you can solve it with finite differences method using algorithms such as Crank-Nicolson.

<t>Thanks for the answers ¡ Regarding delta hedging, I think should have choosen another example of non hedgeable such as S^3 instead of S^2 (thanks bwarren). For these options then, the drift used to model the underlying does matter isn't?Regarding volatility, which is the preferred by practioners ...

Thanks for the answer ¡Wouldn't be an example of non delta hedgeable a derivative with payoff S^2?

Thanks for your answer. Only a question, the point of irrelevant drift is only meaningful in the case of delta hedgeable derivatives?

Which would be the recommended drift and volatility to build stochastic models for stocks? There is a common practice in the industry? Thanks.

<t>In the calculation of std it is useful to me to think about about degrees of freedom as the number of possible independent deviations from the mean (numerator of the formula). As the mean is an estimated figure, we can not consider the deviation from it, and the opportunities of deviation are n -...

Maybe the market is discounting at a different rate than the one you are using?

Think you have to model the expected cash flows taking into account the collar and then discount with the appropriate Discount Factor.

CAn you provide more details? Thanks

I think you can use the sigma of the model you use.