Approximate hedging problem with transaction costs in stochastic volatility markets
AbstractThis paper investigates the problem of hedging European call options using Leland's strategy in stochastic volatility markets with transaction costs. Introducing a new form for the enlarged volatility in Leland's algorithm, we establish a limit theorem and determine a convergence rate for the hedging error. This provides a suggestion to release the underhedging property pointed out by Kabanov and Safarian (1997). Possibilities to improve the convergence rate and lower the option price inclusive transaction costs are also discussed.
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Date of creation: 01 Nov 2012
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Leland strategy; transaction costs; quantile hedging; limit theorem;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-11-17 (All new papers)
- NEP-FMK-2012-11-17 (Financial Markets)
- NEP-ORE-2012-11-17 (Operations Research)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Hayne E. Leland., 1984.
"Option Pricing and Replication with Transactions Costs,"
Research Program in Finance Working Papers
144, University of California at Berkeley.
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- Y. M. Kabanov & M. Safarian, 1995.
"On Leland's Strategy of Option Pricing with Transaction Costs,"
SFB 373 Discussion Papers
1995,65, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
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- Emmanuel Denis & Yuri Kabanov, 2010. "Mean square error for the Leland–Lott hedging strategy: convex pay-offs," Finance and Stochastics, Springer, vol. 14(4), pages 625-667, December.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- repec:ner:dauphi:urn:hdl:123456789/4654 is not listed on IDEAS
- Hans FÃllmer & Peter Leukert, 1999. "Quantile hedging," Finance and Stochastics, Springer, vol. 3(3), pages 251-273.
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