Asymptotic power utility-based pricing and hedging (Q2257041)

This paper deals with a securities market which consists of \(d+1\) assets, a bond and \(d\) stocks. Let \(S=(S^1,\ldots,S^{d})\) be the discounted price process of the \(d\) stocks. The process \(S\) is assumed to be a semimartingale. An investor is considered whose preferences are modeled by a power utility function \(u(x)=x^{1-\rho}/(1-\rho)\). Given an initial endowment \(v>0\), the investor solves the pure investment problem \[ U(v):=\sup_{\varphi\in\Theta(v)} E(u(v+\varphi\bullet S_{T})), \] where the set \(\Theta(v)\) of admissible strategies for initial endowment \(v\) is given by \[ \Theta(v):=\{\varphi\in L(S):\;v+\varphi\bullet S\geq 0\}, \] for a semimartingale \(X\) the class of predictable \(X\)-integrable processes is denoted by \(L(X)\) and the stochastic integral of \(\varphi\in L(X)\) with respect to \(X\) by \(\varphi\bullet X\). In addition to the traded securities, a non-traded European contingent claim with maturity \(T\) and payment function \(H\) is considered. Let an initial endowment \(v>0\) be given. If the investor sells \(q\) units of \(H\) for a price of \(x\in \mathbb R\) each, her initial position consists of \(v+qx\) in cash as well as \(-q\) units of the contingent claim \(H\). Fix \(q\in \mathbb R\). A number \(\pi^{q}\in \mathbb R\) is called utility indifference price of \(H\) if \[ U^{q}(v+q\pi^{q})=U(v), \] where \[ U^{q}(v+qx):=\sup_{\varphi\in\Theta^{q}(v+qx)} E(u(v+qx+\varphi\bullet S_{T}-qH)). \] It is proved that there exists \(\varphi^{q}\in \Theta^{q}(v+q\pi^{q})\) such that \[ E(u(v+q\pi^{q}+\varphi^{q}\bullet S_{T}-qH))=U^{q}(v+q\pi^{q}). \] Without contingent claims, the investor will trade according to the strategy \(\hat\varphi\), whereas she will invest into \(\varphi^{q}\) if she sells \(q\) units of \(H\) for \(\pi^ q\) each. The trading strategy \(\varphi^ q-\hat\varphi\) is called utility-based hedging strategy. The real numbers \(\pi^0\) and \(\pi'\) are called marginal utility-based price, respectively risk premium per option sold if \(\pi^ q=\pi^0+q\pi'+o(q)\) for \(q\to0\). A trading strategy \(\varphi'\in L(S)\) is called marginal utility-based hedging strategy if there exists \(v'\in \mathbb R\) such that \[ \lim_{q\to0}((v+q\pi^ q+\varphi^ q\bullet S_{T})-(v+\hat\varphi\bullet S_{T})-q(v'+\varphi'\bullet S_{T}))/q=0 \] in probability and \((v'+\varphi'\bullet S)\hat Y\) is a martingale for the dual minimizer \(\hat Y\) of the pure investment problem. The authors review the asymptotic results of Kramkov and Sîrbu and derive a feedback formula for the utility-based hedging strategy. The alternative representations for \(\varphi'\) and \(\pi'\) are developed and it is explained how to apply the general theory to exponential Lévy processes, and the stochastic volatility model of Barndorff-Nielsen and Shepard. A numerical example is presented.