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Replication Methods in the Pricing and Hedging of Barrier Options

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  • Tichý Tomáš
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    Abstract

    This paper considers various options replication methods. Firstly, a specific type of barrier option, an up-and-out call, is considered. Other barrier options are briefly also described, and various types of barriers are considered. Secondly, a general definition of replication methods is provided. Two methods are thus examined in detail: The first one, based on ever-changing positions in replicating portfolio, is referred to as a dynamic replication method. The second one is denoted as a static replication method ? its aim is to create a static basket of simple assets that will replicate the option payoff. However, in the real world it is difficult to attain perfect replication; therefore, the expected replication error of both methods is studied via simulation technique.

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    File URL: http://journal.fsv.cuni.cz/storage/979_s_305_324.pdf
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    Bibliographic Info

    Article provided by Charles University Prague, Faculty of Social Sciences in its journal Finance a uver - Czech Journal of Economics and Finance.

    Volume (Year): 54 (2004)
    Issue (Month): 7-8 (July)
    Pages: 305-324

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    Handle: RePEc:fau:fauart:v:54:y:2004:i:7-8:p:305-324

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    Related research

    Keywords: Options; barrier options; replication methods; dynamic and static replication; replication error;

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