The Cost of Risk and Option Hedging in Incomplete Markets PDF Download

Author: Vera Minina
Publisher:
ISBN: 9789036526111
Category :
Languages : en
Pages : 110

View

Book Description

Author: Alfredo Ibañez
Publisher:
ISBN:
Category :
Languages : en
Pages :

View

Book Description
Consider a non-spanned security C_T in an incomplete market. We study the risk/return trade-offs generated if this security is sold for an arbitrage-free price 'c0' and then hedged. We consider recursive one-period optimal self-financing hedging strategies, a simple but tractable criterion. For continuous trading, diffusion processes, the one-period minimum variance portfolio is optimal. Let C_0(0) be its price. Self-financing implies that the residual risk is equal to the sum of the one-period orthogonal hedging errors, sum Y_t(0) . To compensate the residual risk, a risk premium y_t ?t is associated with every Y_t. Now let C_0(y) be the price of the hedging portfolio, and sum (Y_t(y) + y_t ?t) is the total residual risk. Although not the same, the one-period hedging errors Y_t (0) and Y_t (y) are orthogonal to the trading assets, and are perfectly correlated. This implies that the spanned option payoff does not depend on y. Let c0=C_0(y). A main result follows. Any arbitrage-free price, c0, is just the price of a hedging portfolio (such as in a complete market), C_0(0), plus a premium, c0-C_0(0). That is, C_0(0) is the price of the option's payoff which can be spanned, and c0-C_0(0) is the premium associated with the option's payoff which cannot be spanned (and yields a contingent risk premium of sum y_t ?t at maturity). We study other applications of option-pricing theory as well.

Author: Thierry Chauveau
Publisher:
ISBN:
Category : Pricing
Languages : en
Pages : 31

View

Book Description

Author: Dimitris Bertsimas
Publisher:
ISBN:
Category : Arbitrage
Languages : en
Pages : 80

View

Book Description

Author: Tao Hao
Publisher:
ISBN:
Category :
Languages : en
Pages : 14

View

Book Description
This paper has reviewed the literature on options pricing in incomplete markets. A tight upper and lower bounds can be derived based on the assumptions of mean and variance of the underlying asset price, not on its entire distribution. The differences between estimated upper or lower bounds and Black-Scholes price are quite small for deep in-the-money options, but can be very significant for deep out-of-the-money options. But at the same time, despite the wide pricing bounds, analysis of the implied hedging bounds suggests that the implications for asset allocation of incomplete markets are fairly limited.

Author: Maria-Cristina Patron
Publisher:
ISBN:
Category :
Languages : en
Pages : 346

View

Book Description

Author: PeiLin Billy Hsieh
Publisher:
ISBN:
Category :
Languages : en
Pages : 45

View

Book Description
We investigate the effects of return jumps on option bid-ask spreads measured in implied volatility. To explain bid-ask spread quoting behavior, we construct a general model with market makers trading in an incomplete market in which a Bernoulli-type jump could occur. Following a numerical analysis of equilibrium, we apply a nonparametric method to identify the jump components and then test the validity of our theoretical findings. Our results strongly suggest that, at a low jump arrival rate, the dynamic hedging of diffusion movement outperforms static hedging which considers both diffusion and jump risks together, and market makers should apply a dynamic hedging strategy most of the time. A testable implication of quoting behavior, which assumes market makers apply dynamic hedging, is ratified in our empirical work. Additionally, our regression shows that bid-ask volatility spread increases by 0.742% for a one-standard-deviation increase in our defined nonlinear jump factor and by 0.247% for the factor of diffusion volatility. We obtain a R2 value above 80%, and the jump risk factor is characterized by t-statistics above 7, whereas diffusion volatility is only marginally significant. Thus, this paper theoretically explains why and how the jump risk affects options' bid-ask spread and empirically shows that the jump risk influences options' liquidity both statistically and economically.

Author: Dan Chen
Publisher:
ISBN:
Category :
Languages : en
Pages :

View

Book Description
The thesis focuses on valuation and hedging problems when the market is incomplete. The first essay considers the quadratic hedging strategy. We propose a generalized quadratic hedging strategy which can balance a short-term risk (additional cost) with a long-term risk (hedging errors). The traditional quadratic hedging strategies, i.e. self-financing strategy and risk-minimization strategy, can be seen as special cases of the generalized quadratic hedging strategy. This is applied to the insurance derivatives market. The second essay compares parametric and nonparametric measure-changing techniques. The essay discusses three pricing approaches: pricing via Esscher measure, via calibration and via nonparametric risk-neutral density; and empirically compares the performance of the three approaches in the metal futures markets. The last essay establishes the concept of stochastic volatility of volatility and proposes several estimation methods.

Author: Patrick Cusatis
Publisher: McGraw Hill Professional
ISBN: 9780071454537
Category : Business & Economics
Languages : en
Pages : 396

View

Book Description
Books on complex hedging instruments are often more confusing than the instruments themselves. Hedging Instruments & Risk Management brings clarity to the topic, giving money managers the straightforward knowledge they need to employ hedging tools and techniques in four key markets—equity, currency, fixed income, and mortgage. Using real-world data and examples, this high-level book shows practitioners how to develop a common set of mathematical and statistical tools for hedging in various markets and then outlines several hedging strategies with the historical performance of each.

Author: Richard Lehman
Publisher: John Wiley & Sons
ISBN: 1118022262
Category : Business & Economics
Languages : en
Pages : 224

View

Book Description
Practical option strategies for the new post-crisis financial market Traditional buy-and-hold investing has been seriously challenged in the wake of the recent financial crisis. With economic and market uncertainty at a very high level, options are still the most effective tool available for managing volatility and downside risk, yet they remain widely underutilized by individuals and investment managers. In Options for Volatile Markets, Richard Lehman and Lawrence McMillan provide you with specific strategies to lower portfolio volatility, bulletproof your portfolio against any catastrophe, and tailor your investments to the precise level of risk you are comfortable with. While the core strategy of this new edition remains covered call writing, the authors expand into more comprehensive option strategies that offer deeper downside protection or even allow investors to capitalize on market or individual stock volatility. In addition, they discuss new offerings like weekly expirations and options on ETFs. For investors who are looking to capitalize on global investment opportunities but are fearful of lurking "black swans", this book shows how ETFs and options can be utilized to construct portfolios that are continuously protected against unforeseen calamities. A complete guide to the increased control and lowered risk covered call writing offers active investors and traders Addresses the changing investment environment and how to use options to succeed within it Explains how to use options with exchange-traded funds Understanding options is now more important than ever, and with Options for Volatile Markets as your guide, you'll quickly learn how to use them to protect your portfolio as well as improve its overall performance.