J.A. Primbs (USA) and Y. Yamada (Japan)
Hedging, Transaction Costs, Derivatives, Risk Analysis, Moments.
This paper builds a framework for analyzing dynamic hedging strategies under transaction costs. First, self financing portfolio dynamics under transaction costs are modeled or approximated as being portfolio affine. An algorithm for computing the moments of the hedging er ror under portfolio affine dynamics is then used to effi ciently analyze the performance of various hedging strate gies. This approach is applied to the hedging of a Euro pean call option with a Black-Scholes delta hedge and Le land's adjustment for transaction costs. Results are pre sented comparing these two approaches, and analyzing im portant tradeoffs in hedging under transaction costs.
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