Optimal static-dynamic hedges for exotic options under convex risk measures (Q734655)

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.