Optimal static-dynamic hedges for exotic options under convex risk measures (Q734655): Difference between revisions

The problem of hedging an exotic option is considered in this paper. An investor, having an exotic option, hedges her or his position using a combined strategy by trading the underlying stock and bonds dynamically, and vanilla options available in the market statically. The investor assesses the risk of a given trading strategy by \(\rho(V_T)\), where \(\rho\) is a convex risk measure, and \(V_T\) is a wealth of portfolio. The investor tries to minimize the risks. The sufficient conditions on an abstract convex risk measure for existence of an optimal static-dynamic hedge of the exotic options are given. The problem is analyzed in detail under shortfall risk measure with a power loss function. The conditions for uniqueness of the static hedge are given. Next, the computation of the optimal hedge within a dynamic Brownian motion based financial model for an option on a non-traded asset, using a correlated tradeable asset, is presented.