Perfect option hedging for a large trader
AbstractStandard derivative pricing theory is based on the assumption of agents acting as price takers on the market for the underlying asset. We relax this hypothesis and study if and how a large agent whose trades move prices can replicate the payoff of a derivative security. Our analysis extends prior work of Jarrow to economies with continuous security trading. We characterize the solution to the hedge problem in terms of a nonlinear partial differential equation and provide results on existence and uniqueness of this equation. Simulations are used to compare the hedging strategies in our model to standard Black-Scholes strategies.
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Bibliographic InfoArticle provided by Springer in its journal Finance and Stochastics.
Volume (Year): 2 (1998)
Issue (Month): 2 ()
Note: received: April 1996; final version received: April 1997
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Web page: http://www.springerlink.com/content/101164/
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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