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

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• scientific article; zbMATH DE number 1867106

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)

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