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Hedging Errors Induced by Discrete Trading Under an Adaptive Trading Strategy

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  • Mats Brod\'en
  • Magnus Wiktorsson
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    Abstract

    Discrete time hedging in a complete diffusion market is considered. The hedge portfolio is rebalanced when the absolute difference between delta of the hedge portfolio and the derivative contract reaches a threshold level. The rate of convergence of the expected squared hedging error as the threshold level approaches zero is analyzed. The results hinge to a great extent on a theorem stating that the difference between the hedge ratios normalized by the threshold level tends to a triangular distribution as the threshold level tends to zero.

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    File URL: http://arxiv.org/pdf/1004.4526
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1004.4526.

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    Date of creation: Apr 2010
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    Handle: RePEc:arx:papers:1004.4526

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    Web page: http://arxiv.org/

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    1. Emmanuel Temam & Emmanuel Gobet, 2001. "Discrete time hedging errors for options with irregular payoffs," Finance and Stochastics, Springer, Springer, vol. 5(3), pages 357-367.
    2. Takaki Hayashi & Per A. Mykland, 2005. "Evaluating Hedging Errors: An Asymptotic Approach," Mathematical Finance, Wiley Blackwell, Wiley Blackwell, vol. 15(2), pages 309-343.
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