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Efficient Option Replication in the Presence of Transactions Costs

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  • Lionel Martellini

Abstract

In the presence of transaction costs, a risk-return trade-off exists between the quality and the cost of a replicating strategy. In that context, I show how to expand the set of all possible time-based strategies through the introduction of a multi-scale class of strategies, which consist in rebalancing different fractions of an option portfolio at different time frequencies. The method, based on time-scale diversification, is to dynamic replication what investment in diversified portfoliosis to static portfolio selection: in a dynamic context, one may enjoy the benefits of diversification by using different time scales in trading the same asset. Copyright Kluwer Academic Publishers 2000

Suggested Citation

  • Lionel Martellini, 2000. "Efficient Option Replication in the Presence of Transactions Costs," Review of Derivatives Research, Springer, vol. 4(2), pages 107-131, May.
    • Handle: RePEc:kap:revdev:v:4:y:2000:i:2:p:107-131
    DOI: 10.1023/A:1009632624999
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    References listed on IDEAS

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    1. Jouini Elyes & Kallal Hedi, 1995. "Martingales and Arbitrage in Securities Markets with Transaction Costs," Journal of Economic Theory, Elsevier, vol. 66(1), pages 178-197, June.
    2. Leland, Hayne E, 1985. "Option Pricing and Replication with Transactions Costs," Journal of Finance, American Finance Association, vol. 40(5), pages 1283-1301, December.
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    11. Fulvio Ortu, 2001. "Arbitrage, linear programming and martingales¶in securities markets with bid-ask spreads," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 24(2), pages 79-105, November.
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    Cited by:

    1. G. Mazzei & F. G. Bellora & J. A. Serur, 2021. "Delta Hedging with Transaction Costs: Dynamic Multiscale Strategy using Neural Nets," Papers 2109.12337, arXiv.org.
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