Hedging with physical or cash settlement under transient multiplicative price impact

DOI10.1007/S00780-024-00531-7arXiv1807.05917OpenAlexW4392850455MaRDI QIDQ6130331FDOQ6130331

Authors: Dirk Becherer, Todor Bilarev 

Publication date: 2 April 2024

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

Abstract: We solve the superhedging problem for European options in an illiquid extension of the Black-Scholes model, in which transactions have transient price impact and the costs and the strategies for hedging are affected by physical or cash settlement requirements at maturity. Our analysis is based on a convenient choice of reduced effective coordinates of magnitudes at liquidation for geometric dynamic programming. The price impact is transient over time and multiplicative, ensuring non-negativity of underlying asset prices while maintaining an arbitrage-free model. The basic (log-)linear example is a Black-Scholes model with relative price impact being proportional to the volume of shares traded, where the transience for impact on log-prices is being modelled like in Obizhaeva-Wang cite{ObizhaevaWang13} for nominal prices. More generally, we allow for non-linear price impact and resilience functions. The viscosity solutions describing the minimal superhedging price are governed by the transient character of the price impact and by the physical or cash settlement specifications. Pricing equations under illiquidity extend no-arbitrage pricing a la Black-Scholes for complete markets in a non-paradoxical way (cf. {c{C}}etin, Soner and Touzi cite{CetinSonerTouzi10}) even without additional frictions, and can recover it in base cases.

Full work available at URL: https://arxiv.org/abs/1807.05917

zbMATH Keywords

viscosity solutionhedgingresiliencetransient price impacteffective coordinatesgeometric dynamical programmingmultiplicative impactoption settlement

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Dynamic programming in optimal control and differential games (49L20) Viscosity solutions to Hamilton-Jacobi equations in optimal control and differential games (49L25) Applications of stochastic analysis (to PDEs, etc.) (60H30)

Cites Work

• User’s guide to viscosity solutions of second order partial differential equations
• Price Manipulation and Quasi-Arbitrage
• Dynamic programming for stochastic target problems and geometric flows
• When terminal facelift enforces delta constraints
• Optimal Execution in a General One-Sided Limit-Order Book
• Order book resilience, price manipulation, and the positive portfolio problem
• Option hedging for small investors under liquidity costs
• Perfect option hedging for a large trader
• Nonlinear Black-Scholes equations in finance: associated control problems and properties of solutions
• Hedging and Portfolio Optimization in Financial Markets with a Large Trader
• The Feedback Effect of Hedging in Illiquid Markets
• An Introduction to the Theory of Viscosity Solutions for First-Order Hamilton–Jacobi Equations and Applications
• Almost-sure hedging with permanent price impact
• Hedging with temporary price impact
• Optimal asset liquidation with multiplicative transient price impact
• Optimal liquidation under stochastic liquidity
• Optimal execution with multiplicative price impact
• Stability for gains from large investors' strategies in \(M_{1}/J_{1}\) topologies
• Hedging of covered options with linear market impact and gamma constraint
• Understanding the dual formulation for the hedging of path-dependent options with price impact

This page was built for publication: Hedging with physical or cash settlement under transient multiplicative price impact

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q6130331)