Asymptotic replication with modified volatility under small transaction costs |
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Authors: | Jiatu Cai Masaaki Fukasawa |
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Institution: | 1.Laboratoire de Probabilités et Modèles Aléatoires,Université Paris Diderot,Paris,France;2.Department of Mathematics,Osaka University,Toyonaka,Japan |
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Abstract: | We consider the dynamic hedging of a European option under a general local volatility model with small proportional transaction costs. Extending the approach of Leland, we introduce a class of continuous strategies of finite cost that asymptotically (super-)replicate the payoff. An associated central limit theorem for the hedging error is proved. We also obtain an explicit trading strategy minimizing the asymptotic error variance. |
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