FRACTIONAL WHITE NOISE CALCULUS AND APPLICATIONS TO FINANCE

The purpose of this paper is to develop a fractional white noise calculus and to apply this to markets modeled by (Wick–) Ito type of stochastic differential equations driven by fractional Brownian motion BH(t); 1/2 < H < 1. We show that if we use an Ito type of stochastic integration with respect to BH(t) (as developed in Ref. 8), then the corresponding Ito fractional Black–Scholes market has no arbitrage, contrary to the situation when the pathwise integration is used. Moreover, we prove that our Ito fractional Black–Scholes market is complete and we compute explicitly the price and replicating portfolio of a European option in this market. The results are compared to the classical results based on standard Brownian motion B(t).