Optimal static quadratic hedging |
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Authors: | Tim Leung |
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Affiliation: | 1. Industrial Engineering &2. Operations Research Department, Columbia University, New York, NY, 10027USA. |
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Abstract: | We propose a flexible framework for hedging a contingent claim by holding static positions in vanilla European calls, puts, bonds and forwards. A model-free expression is derived for the optimal static hedging strategy that minimizes the expected squared hedging error subject to a cost constraint. The optimal hedge involves computing a number of expectations that reflect the dependence among the contingent claim and the hedging assets. We provide a general method for approximating these expectations analytically in a general Markov diffusion market. To illustrate the versatility of our approach, we present several numerical examples, including hedging path-dependent options and options written on a correlated asset. |
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Keywords: | Static hedging Leveraged ETF options Substitute hedging |
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