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Mean-Variance Hedging with Uncertain Trade Execution

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  • Koichi Matsumoto

Abstract

This paper studies a hedging problem of a contingent claim in a discrete time model. The contingent claim is hedged by one illiquid risky asset and the hedging error is measured by a quadratic criterion. In our model, trade does not always succeed and then trade times are not only discrete, but also random. The uncertainty of trade execution represents the liquidity risk. First we find an optimal hedging strategy with fixed initial condition. Next we consider an optimal initial condition. Finally, we study a binomial model as a simple example.

Suggested Citation

  • Koichi Matsumoto, 2009. "Mean-Variance Hedging with Uncertain Trade Execution," Applied Mathematical Finance, Taylor & Francis Journals, vol. 16(3), pages 219-252.
  • Handle: RePEc:taf:apmtfi:v:16:y:2009:i:3:p:219-252 DOI: 10.1080/13504860802583972
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    References listed on IDEAS

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    Cited by:

    1. Rossella Agliardi & Ramazan Gençay, 2012. "Hedging through a Limit Order Book with Varying Liquidity," Working Paper series 12_12, Rimini Centre for Economic Analysis.

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    Keywords

    Hedging; derivatives; execution risk;

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