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Hedging options including transaction costs in incomplete markets

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  • Safarian, Mher

Abstract

In this paper we study a hedging problem for European options taking into account the presence of transaction costs. In incomplete markets, i.e. markets without classical restriction, there exists a unique martingale measure. Our approach is based on the Föllmer-Schweizer-Sondermann concept of risk minimizing. In discret time Markov market model we construct a risk minimizing strategy by backwards iteration. The strategy gives a closed-form formula. A continuous time market model using martingale price process shows the existence of a risk minimizing hedging strategy.

Suggested Citation

  • Safarian, Mher, 2014. "Hedging options including transaction costs in incomplete markets," Working Paper Series in Economics 56, Karlsruhe Institute of Technology (KIT), Department of Economics and Business Engineering.
  • Handle: RePEc:zbw:kitwps:56
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    Keywords

    hedging of options; incomplete markets; transaction costs; risk minimization; mean-self strategies;

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