Static replication
Quantitative Finance glossary · Derivatives Pricing & Volatility Surfaces
Definition
The exact replication of a payoff by a fixed (non-dynamically rebalanced) portfolio of vanilla instruments.
Static replication in plain English
'Replicating' a payoff means building a copycat portfolio that pays out exactly the same as some target investment, so the two must cost the same today (otherwise you'd have a free-money loophole). Static replication does this with a 'set it and forget it' recipe: you buy a fixed mix of plain-vanilla instruments (simple, standard options and bonds) once and never touch it again until the end. Think of a cake you assemble from off-the-shelf ingredients in one go and just leave to bake — no fiddling. This is prized because the alternative, constantly re-trading to keep the copy accurate, racks up costs and can go wrong when markets move fast.
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