IDEAS home Printed from https://ideas.repec.org/a/spr/finsto/v3y1999i2p187-201.html
   My bibliography  Save this article

Exploding hedging errors for digital options

Author

Listed:
  • Christoph Gallus

    (Deutsche Bank AG, Equities, Global Equity Derivatives, D-60325 Frankfurt am Main, Germany Manuscript)

Abstract

In the complete market model of geometric Brownian motion, all kinds of exotic options can be priced and hedged perfectly using a delta hedging strategy which duplicates the option's payoff. If trading takes place in a frictionless market, this delta hedging strategy is said to eliminate the option writer's risk completely. It will be shown that for certain contingent claims, for example digital options, the hedge can fail completely if the underlying risky asset does not follow the assumed geometric Brownian motion. Indeed, the hedging error may diverge and delta hedging can actually increase the risk of the option writer.

Suggested Citation

  • Christoph Gallus, 1999. "Exploding hedging errors for digital options," Finance and Stochastics, Springer, vol. 3(2), pages 187-201.
  • Handle: RePEc:spr:finsto:v:3:y:1999:i:2:p:187-201 Note: received: October 1996; final version received: February 1998
    as

    Download full text from publisher

    File URL: http://link.springer.de/link/service/journals/00780/papers/9003002/90030187.pdf
    Download Restriction: Access to the full text of the articles in this series is restricted

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Jaime Cuevas Dermody & R. Tyrrell Rockafellar, 1991. "Cash Stream Valuation In the Face of Transaction Costs and Taxes," Mathematical Finance, Wiley Blackwell, vol. 1(1), pages 31-54.
    2. Bernard Bensaid & Jean-Philippe Lesne & Henri Pagès & José Scheinkman, 1992. "Derivative Asset Pricing With Transaction Costs," Mathematical Finance, Wiley Blackwell, vol. 2(2), pages 63-86.
    3. Lukasz Stettner, 2000. "Option Pricing in Discrete-Time Incomplete Market Models," Mathematical Finance, Wiley Blackwell, vol. 10(2), pages 305-321.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Dell'Era Mario, M.D., 2008. "Pricing of Double Barrier Options by Spectral Theory," MPRA Paper 17502, University Library of Munich, Germany.
    2. Meyer, Thomas O., 2003. "Calculation and comparison of delta-neutral and multiple-Greek dynamic hedge returns inclusive of market frictions," International Review of Economics & Finance, Elsevier, vol. 12(2), pages 207-235.
    3. Dell'Era Mario, M.D., 2008. "Pricing of the European Options by Spectral Theory," MPRA Paper 17429, University Library of Munich, Germany.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spr:finsto:v:3:y:1999:i:2:p:187-201. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sonal Shukla) or (Rebekah McClure). General contact details of provider: http://www.springer.com .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.