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Hedging of contingent claims written on non traded assets under Markov-modulated models

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  • Wei Wang
  • Linyi Qian
  • Wensheng Wang

Abstract

This paper studies the hedging problem of European contingent claims when the underlying asset is non traded. We assume that the share prices of the assets are governed by Markov-modulated processes; that is, the market parameters switch over the time according to a finite-state continuous time Markov chain. Due to the presence of Markov chain the non traded asset, the market which we consider is incomplete, we shall use the local risk minimization method to obtain an optimal hedging strategy in a closed-form for an investor. Finally, numerical illustrations of an optimal hedging strategy are given by the Monte Carlo simulation.

Suggested Citation

  • Wei Wang & Linyi Qian & Wensheng Wang, 2016. "Hedging of contingent claims written on non traded assets under Markov-modulated models," Communications in Statistics - Theory and Methods, Taylor & Francis Journals, vol. 45(12), pages 3577-3595, June.
    • Handle: RePEc:taf:lstaxx:v:45:y:2016:i:12:p:3577-3595
    DOI: 10.1080/03610926.2014.904355
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