Arbitrage opportunities and their implications to derivative hedging

We explore the role that random arbitrage opportunities play in hedging finalicial derivatives. We extend the asymptotic pricing theory presented by Fedotov and Panayides [Stochastic arbitrage return and its implication for option pricing, Physica A 345 (2005) 207-217] for the case of hedging a derivative when arbitrage opportunities are present in the market. We restrict ourselves to finding hedging confidence intervals that call be adapted to the amount of arbitrage risk in investor will permit to be exposed to. The resulting hedging bands are independent of the detailed statistical characteristics of the arbitrage opportunities. (c) 2005 Elsevier B.V. All rights reserved.