Option pricing and hedging with execution costs and market impact
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Publication:5283404
DOI10.1111/MAFI.12102zbMATH Open1380.91130arXiv1311.4342OpenAlexW2268929863MaRDI QIDQ5283404FDOQ5283404
Authors: Olivier Guéant, Jiang Pu 
Publication date: 21 July 2017
Published in: Mathematical Finance (Search for Journal in Brave)
Abstract: This article considers the pricing and hedging of a call option when liquidity matters, that is, either for a large nominal or for an illiquid underlying asset. In practice, as opposed to the classical assumptions of a price-taking agent in a frictionless market, traders cannot be perfectly hedged because of execution costs and market impact. They indeed face a trade-off between hedging errors and costs that can be solved by using stochastic optimal control. Our modelling framework, which is inspired by the recent literature on optimal execution, makes it possible to account for both execution costs and the lasting market impact of trades. Prices are obtained through the indifference pricing approach. Numerical examples are provided, along with comparisons to standard methods.
Full work available at URL: https://arxiv.org/abs/1311.4342
Recommendations
Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) Nonlinear parabolic equations (35K55)
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Cited In (25)
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