Hedging with temporary price impact (Q513749): Difference between revisions
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This paper deals with the problem of hedging a European contingent claim in a Bachelier model with temporary price impact. It is considered an agent who is trading in a financial market consisting of a risky asset. The number of shares the agent holds at time \(t\in [0,T]\) of the risky stock is defined as \(X_{t}^{u}=x+\int_0^{t}u_{s}ds\), where \(x\in R\) denotes her given initial holding. The real-valued stochastic process \((u_{t})_{0\leq t\leq T}\) represents the speed at which the agent trades in the risky asset. It is assumed to be chosen in the set \(U=\left\{u:\;u\;\text{progressively\;measurable\;s.t.}\;E\int_{0}^{T}u_{t}^2 dt<\infty \right\}\). Given a real-valued predictable process \((\xi_{t})_{0\leq t\leq T}\) in \(L^1(P\otimes dt)\) and a fixed constant \(\kappa>0\), the agent's objective is to minimize the performance functional \(J(u)=E\left[(1/2)\int_0^{T}(X_{t}^{u}-\xi_{t})^2 dt+(1/2)\kappa\int_0^{T}u_{t}^2 dt\right]\). This leads to the optimal stochastic control problem \(J(u)\to\min_{u\in U}\). Let us denote \(\tau^{\kappa}(t)=(T-t)/\sqrt{\kappa}\), \(0\leq t\leq T\). One of the main results of paper is following. The optimal stock holding \(\hat X\) of considered stochastic optimal control problem with unconstrained terminal position satisfy the linear ordinary differential equation \(d\hat X_{t}=\frac{\tanh(\tau^{\kappa}(t))}{\sqrt{\kappa}}(\hat\xi_{t}-\hat X_{t})dt\), \(\hat x_0=x\), where, for \(0\leq t<T\), we let \(\hat\xi_{t}=E\left[\int_{t}^{T}\xi_{u}K(t,u)du|{\mathcal F}_{t}\right]\) with kernel \(K(t,u)=\cosh(\tau^{\kappa}(u))/(\sqrt{\kappa}\sinh(\tau^{\kappa}(t)))\), \(0\leq t\leq u<T\). The minimal costs are given by \(\inf_{u\in U}J(u)=\frac{1}{2}\sqrt{\kappa}\tanh(\tau^{\kappa}(0))(x-\hat\xi_0)^2+\frac{1}{2}E\left[ \int_0^{T}(\xi_{t}-\hat\xi_{t})^2dt\right]+ \frac{1}{2}E\left[\int_0^{T}\sqrt{\kappa}\tanh(\tau^{\kappa}(t))d\langle\hat\xi\rangle_{t}\right]<\infty\). The similar result is obtained for the constrained problem with given agent's terminal position \(X_{T}^{u}=\Theta_{T}\). | |||
Property / review text: This paper deals with the problem of hedging a European contingent claim in a Bachelier model with temporary price impact. It is considered an agent who is trading in a financial market consisting of a risky asset. The number of shares the agent holds at time \(t\in [0,T]\) of the risky stock is defined as \(X_{t}^{u}=x+\int_0^{t}u_{s}ds\), where \(x\in R\) denotes her given initial holding. The real-valued stochastic process \((u_{t})_{0\leq t\leq T}\) represents the speed at which the agent trades in the risky asset. It is assumed to be chosen in the set \(U=\left\{u:\;u\;\text{progressively\;measurable\;s.t.}\;E\int_{0}^{T}u_{t}^2 dt<\infty \right\}\). Given a real-valued predictable process \((\xi_{t})_{0\leq t\leq T}\) in \(L^1(P\otimes dt)\) and a fixed constant \(\kappa>0\), the agent's objective is to minimize the performance functional \(J(u)=E\left[(1/2)\int_0^{T}(X_{t}^{u}-\xi_{t})^2 dt+(1/2)\kappa\int_0^{T}u_{t}^2 dt\right]\). This leads to the optimal stochastic control problem \(J(u)\to\min_{u\in U}\). Let us denote \(\tau^{\kappa}(t)=(T-t)/\sqrt{\kappa}\), \(0\leq t\leq T\). One of the main results of paper is following. The optimal stock holding \(\hat X\) of considered stochastic optimal control problem with unconstrained terminal position satisfy the linear ordinary differential equation \(d\hat X_{t}=\frac{\tanh(\tau^{\kappa}(t))}{\sqrt{\kappa}}(\hat\xi_{t}-\hat X_{t})dt\), \(\hat x_0=x\), where, for \(0\leq t<T\), we let \(\hat\xi_{t}=E\left[\int_{t}^{T}\xi_{u}K(t,u)du|{\mathcal F}_{t}\right]\) with kernel \(K(t,u)=\cosh(\tau^{\kappa}(u))/(\sqrt{\kappa}\sinh(\tau^{\kappa}(t)))\), \(0\leq t\leq u<T\). The minimal costs are given by \(\inf_{u\in U}J(u)=\frac{1}{2}\sqrt{\kappa}\tanh(\tau^{\kappa}(0))(x-\hat\xi_0)^2+\frac{1}{2}E\left[ \int_0^{T}(\xi_{t}-\hat\xi_{t})^2dt\right]+ \frac{1}{2}E\left[\int_0^{T}\sqrt{\kappa}\tanh(\tau^{\kappa}(t))d\langle\hat\xi\rangle_{t}\right]<\infty\). The similar result is obtained for the constrained problem with given agent's terminal position \(X_{T}^{u}=\Theta_{T}\). / rank | |||
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Property / reviewed by | |||
Property / reviewed by: Aleksandr D. Borisenko / rank | |||
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Property / Mathematics Subject Classification ID | |||
Property / Mathematics Subject Classification ID: 91G20 / rank | |||
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Property / Mathematics Subject Classification ID | |||
Property / Mathematics Subject Classification ID: 91G10 / rank | |||
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Property / Mathematics Subject Classification ID | |||
Property / Mathematics Subject Classification ID: 91G80 / rank | |||
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Property / Mathematics Subject Classification ID | |||
Property / Mathematics Subject Classification ID: 93E20 / rank | |||
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Property / Mathematics Subject Classification ID | |||
Property / Mathematics Subject Classification ID: 60H30 / rank | |||
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Property / zbMATH DE Number | |||
Property / zbMATH DE Number: 6692621 / rank | |||
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Property / zbMATH Keywords | |||
hedging | |||
Property / zbMATH Keywords: hedging / rank | |||
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European contingent claim | |||
Property / zbMATH Keywords: European contingent claim / rank | |||
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Property / zbMATH Keywords | |||
Bachelier model | |||
Property / zbMATH Keywords: Bachelier model / rank | |||
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price impact | |||
Property / zbMATH Keywords: price impact / rank | |||
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illiquid markets | |||
Property / zbMATH Keywords: illiquid markets / rank | |||
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Property / zbMATH Keywords | |||
portfolio tracking | |||
Property / zbMATH Keywords: portfolio tracking / rank | |||
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Revision as of 04:33, 1 July 2023
scientific article
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English | Hedging with temporary price impact |
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Hedging with temporary price impact (English)
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7 March 2017
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This paper deals with the problem of hedging a European contingent claim in a Bachelier model with temporary price impact. It is considered an agent who is trading in a financial market consisting of a risky asset. The number of shares the agent holds at time \(t\in [0,T]\) of the risky stock is defined as \(X_{t}^{u}=x+\int_0^{t}u_{s}ds\), where \(x\in R\) denotes her given initial holding. The real-valued stochastic process \((u_{t})_{0\leq t\leq T}\) represents the speed at which the agent trades in the risky asset. It is assumed to be chosen in the set \(U=\left\{u:\;u\;\text{progressively\;measurable\;s.t.}\;E\int_{0}^{T}u_{t}^2 dt<\infty \right\}\). Given a real-valued predictable process \((\xi_{t})_{0\leq t\leq T}\) in \(L^1(P\otimes dt)\) and a fixed constant \(\kappa>0\), the agent's objective is to minimize the performance functional \(J(u)=E\left[(1/2)\int_0^{T}(X_{t}^{u}-\xi_{t})^2 dt+(1/2)\kappa\int_0^{T}u_{t}^2 dt\right]\). This leads to the optimal stochastic control problem \(J(u)\to\min_{u\in U}\). Let us denote \(\tau^{\kappa}(t)=(T-t)/\sqrt{\kappa}\), \(0\leq t\leq T\). One of the main results of paper is following. The optimal stock holding \(\hat X\) of considered stochastic optimal control problem with unconstrained terminal position satisfy the linear ordinary differential equation \(d\hat X_{t}=\frac{\tanh(\tau^{\kappa}(t))}{\sqrt{\kappa}}(\hat\xi_{t}-\hat X_{t})dt\), \(\hat x_0=x\), where, for \(0\leq t<T\), we let \(\hat\xi_{t}=E\left[\int_{t}^{T}\xi_{u}K(t,u)du|{\mathcal F}_{t}\right]\) with kernel \(K(t,u)=\cosh(\tau^{\kappa}(u))/(\sqrt{\kappa}\sinh(\tau^{\kappa}(t)))\), \(0\leq t\leq u<T\). The minimal costs are given by \(\inf_{u\in U}J(u)=\frac{1}{2}\sqrt{\kappa}\tanh(\tau^{\kappa}(0))(x-\hat\xi_0)^2+\frac{1}{2}E\left[ \int_0^{T}(\xi_{t}-\hat\xi_{t})^2dt\right]+ \frac{1}{2}E\left[\int_0^{T}\sqrt{\kappa}\tanh(\tau^{\kappa}(t))d\langle\hat\xi\rangle_{t}\right]<\infty\). The similar result is obtained for the constrained problem with given agent's terminal position \(X_{T}^{u}=\Theta_{T}\).
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hedging
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European contingent claim
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Bachelier model
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price impact
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illiquid markets
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portfolio tracking
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