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;
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SFB 373 Discussion Papers
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