It has often been argued that there exists an underlying biological basis of utility functions. Taking this line of argument a step further in this paper, we have aimed to computationally demonstrate the biological basis of the Black-Scholes functional form as applied to classical option pricing and hedging theory. The evolutionary optimality of the classical Black-Scholes function has been computationally established by means of a haploid genetic algorithm model. The objective was to minimize the dynamic hedging error for a portfolio of assets that is built to replicate the payoff from a European multi-asset option. The functional form that is seen to evolve over successive generations which best attains this optimization objective is the classical Black-Scholes function extended to a multiasset scenario.
|Number of pages||15|
|Journal||Journal of Applied Mathematics and Decision Sciences|
|Publication status||Published - 2007|