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Hedging under an expected loss constraint with small transaction costs

Author

Listed:
  • Bruno Bouchard

    (CEREMADE, CREST)

  • Ludovic Moreau
  • Mete H. Soner

Abstract

We consider the problem of option hedging in a market with proportional transaction costs. Since super-replication is very costly in such markets, we replace perfect hedging with an expected loss constraint. Asymptotic analysis for small transactions is used to obtain a tractable model. A general expansion theory is developed using the dynamic programming approach. Explicit formulae are also obtained in the special cases of an exponential or power loss function. As a corollary, we retrieve the asymptotics for the exponential utility indifference price.

Suggested Citation

  • Bruno Bouchard & Ludovic Moreau & Mete H. Soner, 2013. "Hedging under an expected loss constraint with small transaction costs," Papers 1309.4916, arXiv.org, revised Sep 2014.
    • Handle: RePEc:arx:papers:1309.4916
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    File URL: http://arxiv.org/pdf/1309.4916
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    References listed on IDEAS

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    Cited by:

    1. Ludovic Moreau & Johannes Muhle-Karbe & H. Mete Soner, 2014. "Trading with Small Price Impact," Papers 1402.5304, arXiv.org, revised Mar 2015.
    2. Dylan Possamai & Guillaume Royer, 2014. "General indifference pricing with small transaction costs," Papers 1401.3261, arXiv.org, revised Apr 2015.

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