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Hedging error in Lévy models with a Fast Fourier Transform approach

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  • Flavio Angelini
  • Marco Nicolosi

Abstract

We measure, in terms of expectation and variance, the cost of hedging a contingent claim when the hedging portfolio is re-balanced at a discrete set of dates. The basic point of the methodology is to have an integral representation of the payoff of the claim, in other words to be able to write the payoff as an inverse Laplace transform. The models under consideration belong to the class of Lévy models, like NIG, VG and Merton models. The methodology is implemented through the popular FFT algorithm, used by many financial institutions for pricing and calibration purposes. As applications, we analyze the effect of increasing the number of tradings and we make some robustness tests.

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Bibliographic Info

Paper provided by Università di Perugia, Dipartimento Economia, Finanza e Statistica in its series Quaderni del Dipartimento di Economia, Finanza e Statistica with number 43/2008.

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Length: 30 pages
Date of creation: 01 Feb 2008
Date of revision:
Handle: RePEc:pia:wpaper:43/2008

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Keywords: Hedging; Lévy models; Fast Fourier Transform;

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Cited by:
  1. Flavio Angelini & Stefano Herzel, 2010. "Explicit formulas for the minimal variance hedging strategy in a martingale case," Decisions in Economics and Finance, Springer, vol. 33(1), pages 63-79, May.

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