Optimal Hedging when the Underlying Asset Follows a Regime-switching Markov Process
AbstractWe develop a flexible discrete-time hedging methodology that minimizes the expected value of any desired penalty function of the hedging error within a general regime-switching framework. A numerical algorithm based on backward recursion allows for the sequential construction of an optimal hedging strategy. Numerical experiments comparing this and other methodologies show a relative expected penalty reduction ranging between 0.9% and 12.6% with respect to the best benchmark.
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Bibliographic InfoPaper provided by CIRPEE in its series Cahiers de recherche with number 1234.
Date of creation: 2012
Date of revision:
Dynamic programming; hedging; risk management; regime switching;
Find related papers by JEL classification:
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-09-09 (All new papers)
- NEP-ORE-2012-09-09 (Operations Research)
- NEP-RMG-2012-09-09 (Risk Management)
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