J.A. Primbs, S. Mudchanatongsuk, and W. Wong (USA)
Financial Derivatives, Dynamic Hedging, Receding Hori zon Control, Basket Options.
In this paper we develop a semi-definite programming based receding horizon control approach to the problem of dynamic hedging of European basket call options. The hedging problem for a European call option is formulated as a finite horizon constrained stochastic control problem. This allows us to develop a receding horizon control ap proach that repeatedly solves semi-definite programs on line in order to dynamically hedge. This approach is com petitive with Black-Scholes in the one-dimensional case, but also scales well with problem size, applies to basket options, and can potentially include other forms of con straints. We illustrate its effectiveness through numerical examples.
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