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(S,s)-adjustment Strategies and Hedging under Markovian Dynamics

  • Elettra Agliardi

    ()

    (Department of Economics, University of Bologna, Piazza Scaravilli, 2, 40126 Bologna (BO), Italy.
    Department of Economics, University of Bologna, Piazza Scaravilli, 2, 40126 Bologna (BO), Italy.)

  • Rainer Andergassen

    ()

    (Department of Economics, University of Bologna, Piazza Scaravilli, 2, 40126 Bologna (BO), Italy.
    Department of Economics, University of Bologna, Piazza Scaravilli, 2, 40126 Bologna (BO), Italy.)

We study the destabilizing effect of hedging strategies under Markovian dynamics with transaction costs. Once transaction costs are taken into account, continuous portfolio rehedging is no longer an optimal strategy. Using a non-optimizing (local in time) strategy for portfolio rebalancing, explicit dynamics for the price of the underlying asset are derived, focusing in particular on excess volatility and feedback effects of these portfolio insurance strategies. Moreover, it is shown how these latter depend on the heterogeneity of the insured payoffs. Finally, conditions are derived under which it may be still reasonable, from a practical viewpoint, to implement Black–Scholes strategies.

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Article provided by Palgrave Macmillan in its journal The Geneva Risk and Insurance Review.

Volume (Year): 36 (2011)
Issue (Month): 2 (December)
Pages: 112-131

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Handle: RePEc:pal:genrir:v:36:y:2011:i:2:p:112-131
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