Feedback effects of dynamic hedging strategies in the presence of transaction costs
We study the destabilising effect of dynamic hedging strategies on the price of the underlying in the presence of sunk costs of transaction. Once sunk costs of transaction are taken into account, continuous portfolio rehedging is no longer an optimal strategy. Using a non-optimising (local in time) strategy for portfolio rebalancing, explicit dynamics for the price of the underlying are derived, focusing in particular on the excess volatility and feedback effects of these portfolio insurance strategies. Further, we show how these latter depend on the heterogeneity of the insured payoffs. Finally, conditions are derived under which it may still be reasonable, from a practical viewpoint, to implement Black - Scholes strategies.
|Date of creation:||2002|
|Contact details of provider:|| Postal: Piazza Scaravilli, 2, and Strada Maggiore, 45, 40125 Bologna|
Phone: +39 051 209 8019 and 2600
Fax: +39 051 209 8040 and 2664
Web page: http://www.dse.unibo.it
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Ricardo J. Caballero & Eduardo M. R. A. Engel, 1993.
"Microeconomic Adjustment Hazards and Aggregate Dynamics,"
The Quarterly Journal of Economics,
Oxford University Press, vol. 108(2), pages 359-383.
- Ricardo J. Caballero & Eduardo M.R.A. Engel, 1992. "Microeconomic Adjustment Hazards and Aggregate Dynamics," NBER Working Papers 4090, National Bureau of Economic Research, Inc.
- Grossman, Sanford J, 1988. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," The Journal of Business, University of Chicago Press, vol. 61(3), pages 275-298, July.
- Sanford J. Grossman, 1987. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," NBER Working Papers 2357, National Bureau of Economic Research, Inc.
- Rüdiger Frey & Alexander Stremme, 1997. "Market Volatility and Feedback Effects from Dynamic Hedging," Mathematical Finance, Wiley Blackwell, vol. 7(4), pages 351-374.
- Platen, Eckhard & Martin Schweizer, 1994. "On Smile and Skewness," Discussion Paper Serie B 302, University of Bonn, Germany. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:bol:bodewp:445. 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: (Dipartimento Scienze Economiche, Universita' di Bologna)
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.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with 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 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.