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Optimal Dynamic Hedging in Incomplete Futures Markets

In: Financial Risk and Derivatives

Author

Listed:
  • Abraham Lioui

    (University of Paris-I Sorbonne and Bar Ilan University)

  • Pascal Nguyen Duc Trong

    (ESSEC and Université du Littoral)

  • Patrice Poncet

    (University of Paris-I Sorbonne and ESSEC, Département Finance)

Abstract

This article derives optimal hedging demands for futures contracts from an investor who cannot freely trade his portfolio of primitive assets in the context of either a CARA or a logarithmic utility function. Existing futures contracts are not numerous enough to complete the market. In addition, in the case of CARA, the nonnegativity constraint on wealth is binding, and the optimal hedging demands are not identical to those that would be derived if the constraint were ignored. Fictitiously completing the market, we can characterize the optimal hedging demands for futures contracts. Closed-form solutions exist in the logarithmic case but not in the CARA case, since then a put (insurance) written on his wealth is implicitly bought by the investor. Although solutions are formally similar to those that obtain under complete markets, incompleteness leads in fact to second-best optima.

Suggested Citation

  • Abraham Lioui & Pascal Nguyen Duc Trong & Patrice Poncet, 1996. "Optimal Dynamic Hedging in Incomplete Futures Markets," Springer Books, in: Henri Loubergé & Marti G. Subrahmanyam (ed.), Financial Risk and Derivatives, pages 103-122, Springer.
    • Handle: RePEc:spr:sprchp:978-94-009-1826-9_6
    DOI: 10.1007/978-94-009-1826-9_6
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