Asymptotic replication with modified volatility under small transaction costs

DOI10.1007/S00780-016-0294-2MaRDI QIDQ287666zbMATH OpenOpenAlexFDO

Authors Jiatu Cai, Masaaki Fukasawa

Publication date 23 May 2016

Published in Finance and Stochastics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1408.5677

zbMATH Keywords

central limit theoremstochastic optimal controltransaction coststransaction costbenchmark strategydisctretizationoptimal hedging

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Functional limit theorems; invariance principles (60F17) Stochastic ordinary differential equations (aspects of stochastic analysis) (60H10) Applications of stochastic analysis (to PDEs, etc.) (60H30) Optimal stochastic control (93E20)

Abstract: Dynamic hedging of an European option under a general local volatility model with small linear transaction costs is studied. A continuous control version of Leland's strategy that asymptotically replicates the payoff is constructed. An associated central limit theorem of hedging error is proved. The asymptotic error variance is minimized by an explicit trading strategy.

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Cited in

(10)

• Scaling limits of processes with fast nonlinear mean reversion
• A TRANSACTION COST CONVERGENCE RESULT FOR GENERAL HEDGING STRATEGIES
• An endogenous volatility approach to pricing and hedging call options with transaction costs
• Approximate Hedging with Constant Proportional Transaction Costs in Financial Markets with Jumps
• On the microstructural hedging error
• Super-replication with fixed transaction costs
• Hedging Problem for Asian Call Options with Transaction Costs
• Small transaction cost asymptotics and dynamic hedging
• Hedging under an expected loss constraint with small transaction costs
• Approximate hedging problem with transaction costs in stochastic volatility markets

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