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Hedging Barrier Options: Current Methods and Alternatives


  • Dupont, Dominique Y.

    (EURANDOM - TUE, The Netherlands)


This paper applies to the static hedge of barrier options a technique, mean-square hedging, designed to minimize the size of the hedging error when perfect replication is not possible. It introduces an extension of this technique which preserves the computational efficiency of mean-square hedging while being consistent with any prior pricing model or with any linear constraint on the hedging residual. This improves on current static hedging methods, which aim at exactly replicating barrier options and rely on strong assumptions on the availability of traded options with certain strikes or maturities, or on the distribution of the underlying asset.

Suggested Citation

  • Dupont, Dominique Y., 2001. "Hedging Barrier Options: Current Methods and Alternatives," Economics Series 103, Institute for Advanced Studies.
  • Handle: RePEc:ihs:ihsesp:103

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    References listed on IDEAS

    1. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters,in: Theory Of Valuation, chapter 8, pages 229-288 World Scientific Publishing Co. Pte. Ltd..
    2. Peter Carr & Katrina Ellis & Vishal Gupta, 1998. "Static Hedging of Exotic Options," Journal of Finance, American Finance Association, vol. 53(3), pages 1165-1190, June.
    3. Peter G. Zhang, 1998. "Hedging Exotic Options," World Scientific Book Chapters,in: Exotic Options A Guide to Second Generation Options, chapter 35, pages 639-643 World Scientific Publishing Co. Pte. Ltd..
    4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    5. Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
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    Cited by:

    1. J. Maruhn & E. Sachs, 2009. "Robust static hedging of barrier options in stochastic volatility models," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 70(3), pages 405-433, December.
    2. repec:wsi:ijtafx:v:08:y:2005:i:03:n:s0219024905002998 is not listed on IDEAS
    3. Stephane Crepey, 2004. "Delta-hedging vega risk?," Quantitative Finance, Taylor & Francis Journals, vol. 4(5), pages 559-579.

    More about this item


    Barrier options; Static hedging; Mean-square hedging;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques


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