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Hedging Barrier Options: Current Methods and Alternatives

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Author Info

  • Dupont, Dominique Y.

    (EURANDOM - TUE, The Netherlands)

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    Abstract

    This paper applies to the static hedge of barrier options a technique, mean-square hedging, designed to minimize the size of the hedging error when perfect replication is not possible. It introduces an extension of this technique which preserves the computational efficiency of mean-square hedging while being consistent with any prior pricing model or with any linear constraint on the hedging residual. This improves on current static hedging methods, which aim at exactly replicating barrier options and rely on strong assumptions on the availability of traded options with certain strikes or maturities, or on the distribution of the underlying asset.

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    File URL: http://www.ihs.ac.at/publications/eco/es-103.pdf
    File Function: First version, 2001
    Download Restriction: no

    Bibliographic Info

    Paper provided by Institute for Advanced Studies in its series Economics Series with number 103.

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    Length: 34 pages
    Date of creation: Sep 2001
    Date of revision:
    Handle: RePEc:ihs:ihsesp:103

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    Related research

    Keywords: Barrier options; Static hedging; Mean-square hedging;

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    References

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    1. Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
    2. 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.
    3. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
    4. Peter Carr & Katrina Ellis & Vishal Gupta, 1998. "Static Hedging of Exotic Options," Journal of Finance, American Finance Association, vol. 53(3), pages 1165-1190, 06.
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    Cited by:
    1. Sbuelz, A., 2000. "Hedging Double Barriers with Singles," Discussion Paper 2000-112, Tilburg University, Center for Economic Research.

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