Option Pricing and Hedging with Temporal Correlations
  We consider the problem of option pricing and hedging when stock returns are correlated in time. Within a quadratic-risk minimisation scheme, we obtain a general formula, valid for weakly correlated non-Gaussian processes. We show that for Gaussian price increments, the correlations are irrelevant, and the Black-Scholes formula holds with the volatility of the price increments on the scale of the re-hedging. For non-Gaussian processes, further non trivial corrections to the `smile' are brought about by the correlations, even when the hedge is the Black-Scholes Delta-hedge. We introduce a compact notation which eases the computations and could be of use to deal with more complicated models. 
Lorenzo Cornalba (1), Jean-Philippe Bouchaud (2,3) and Marc Potters   (3) ((1) ENS Paris, (2) CEA Saclay,(3) Science & Finan...