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Hedging Option Portfolios In The Presence Of Transaction Costs
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Book Synopsis Hedging Option Portfolios in the Presence of Transaction Costs by : Paul Wilmott
Download or read book Hedging Option Portfolios in the Presence of Transaction Costs written by Paul Wilmott and published by . This book was released on 2019 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: We derive a nonlinear parabolic partial differential equation for the value of portfolios of options in the presence of proportional transaction costs. This assumes a Leland world of transacting after each time interval, which is of fixed length. The equation reduces to the modified variance case described by Leland in the case of a single option. We demonstrate the nonlinear nature of option portfolios and give results for several simple combinations of options.
Book Synopsis Optimal Hedging of Option Portfolios with Transaction Costs by : Valeriy Zakamulin
Download or read book Optimal Hedging of Option Portfolios with Transaction Costs written by Valeriy Zakamulin and published by . This book was released on 2006 with total page 28 pages. Available in PDF, EPUB and Kindle. Book excerpt: One of the most successful approaches to option hedging with transaction costs is the utility based approach pioneered by Hodges and Neuberger (1989). However, this approach has one major drawback that prevents the broad application of this approach in practice: the lack of a closed-form solution. The direct numerical computations of the utility based hedging strategy are cumbersome in a practical implementation. Despite some recent advances in finding an explicit description of the utility based hedging strategy by using either asymptotic, approximation, or other methods, so far they were concerned primarily with hedging a single plain-vanilla option. However, in practice one often faces the problem of hedging a portfolio of options on the same underlying asset. Since the knowledge of the optimal hedging strategy for a portfolio of options is of great practical significance, in this paper we suggest a simplified parameterized description of the utility based hedging strategy for a portfolio of options and a simple method for finding the optimal parameters. We provide an empirical testing of our optimized hedging strategies against some alternative strategies and show that our strategies outperform all the others.
Book Synopsis Yet Another Note on the Leland's Option Hedging Strategy with Transaction Costs by : Valeriy Zakamulin
Download or read book Yet Another Note on the Leland's Option Hedging Strategy with Transaction Costs written by Valeriy Zakamulin and published by . This book was released on 2016 with total page 20 pages. Available in PDF, EPUB and Kindle. Book excerpt: In a market with transaction costs the option hedging is costly. The idea presented by Leland (1985) was to include the expected transaction costs in the cost of a replicating portfolio. The resulting Leland's pricing and hedging method is an adjusted Black-Scholes method where one uses a modified volatility in the Black-Scholes formulas for the option price and delta. The Leland's method has been criticized on different grounds. Despite the critique, the risk-return tradeoff of the Leland's strategy is often better than that of the Black-Scholes strategy even in the case when a hedger starts with the same initial value of a replicating portfolio. This implies that the Leland's modification of volatility does optimize somehow the Black-Scholes hedging strategy in the presence of transaction costs. In this paper we explain how the Leland's modified volatility works and show how the performance of the Leland's hedging strategy can be improved by finding the optimal modified volatility. It is not claimed that the Leland's hedging strategy is optimal. Rather, the optimization mechanism of the modified hedging volatility can be exploited to improve the risk-return tradeoffs of other well-known option hedging strategies in the presence of transaction costs.
Book Synopsis Optimal Hedging Portfolios for Derivative Securities in the Presence of Large Transaction Costs by : Marco Avellaneda
Download or read book Optimal Hedging Portfolios for Derivative Securities in the Presence of Large Transaction Costs written by Marco Avellaneda and published by . This book was released on 1999 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: We introduce a new class of strategies for hedging derivative securities taking into account transaction costs, assuming lognormal continuous-time prices for the underlying asset. We do not assume that the payoff is convex as in Leland (J of Finance, 1985), or that the transaction costs are small compared to the price changes between portfolio adjustments, as in Hoggard, Whalley and Wilmott (Adv. in Futures and Options Res., 1993). The Leland number, A, which is proportional to the ratio of the round-trip tansaction cost over the typical price movement during the period between transactions, is a measure of the importance of transaction costs versus hedging risk. If A is greater than or equal to one, standard delta-hedging methods fail unless the payoff of the derivative security is a convex function of the price of the underlying asset. In contrast, our new strategies can be used effectively in the presence of large transaction costs to control simultaneously hedge-slippage as well as hedging costs. These strategies are associated with the solution an quot;obstacle problemquot; for a Black-Scholes diffusion equation with Leland's quot;augmentedquot; volatility, a parameter which depends on the volatility of the underlying asset as well as on A. The new strategies are such that the frequency for rebalancing the portfolio is variable. There are periods in which rehedging takes place often to control gamma-risk and other periods, which can be relatively long, when no transactions are needed. Moreover, instead of replicating exactly the final payoff, the strategies can yield a positive cash flow at expiration, according to the price history of the underlying security. The solution to the quot;obstacle problemquot; is often simple to calculate. There exist closed-form solutions for various securities of practical interest, such as digital options.
Book Synopsis The Best Hedging Strategy in the Presence of Transaction Costs by : Valeriy Zakamulin
Download or read book The Best Hedging Strategy in the Presence of Transaction Costs written by Valeriy Zakamulin and published by . This book was released on 2008 with total page 27 pages. Available in PDF, EPUB and Kindle. Book excerpt: Considerable theoretical work has been devoted to the problem of option pricing and hedging with transaction costs. A variety of methods have been suggested and are currently being used for dynamic hedging of options in the presence of transaction costs. However, very little was done on the subject of an empirical comparison of different methods for option hedging with transaction costs. In a few existing studies the different methods are compared by studying their empirical performances in hedging only a plain-vanilla short call option. The reader is tempted to assume that the ranking of the different methods for hedging any kind of option remains the same as that for a vanilla call. The main goal of this paper is to show that the ranking of the alternative hedging strategies depends crucially on the type of the option position being hedged and the risk preferences of the hedger. In addition, we present and implement a simple optimization method that, in some cases, improves considerably the performance of some hedging strategies.
Book Synopsis Hedging Strategies of Financial Intermediaries by : Shmuel Hauser
Download or read book Hedging Strategies of Financial Intermediaries written by Shmuel Hauser and published by . This book was released on 2013 with total page 14 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper uses a model similar to the Boyle-Vorst and Ritchken-Kuo arbitrage-free models for the valuation of options with transaction costs to determine the maximum price to be charged by the financial intermediary writing an option in a non-auction market. Earlier models are extended by recognizing that, in the presence of transaction costs, the price-taking intermediary constructing a hedging portfolio faces a tradeoff: to choose a short trading interval with small hedging errors and high transaction costs, or a long trading interval with large hedging errors and low transaction costs. The model presented recognizes that when transaction costs induce less frequent portfolio adjustments, investors are faced with a multinomial distribution of asset returns rather than a binomial one. The price upper bound is determined by selecting the trading frequency that will equalize the marginal benefit from decreasing hedging errors and the marginal cost of transactions.
Book Synopsis Optimal Partial Hedging of Options with Small Transaction Costs by : A. Elizabeth Whalley
Download or read book Optimal Partial Hedging of Options with Small Transaction Costs written by A. Elizabeth Whalley and published by . This book was released on 2019 with total page 49 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper uses asymptotic analysis to derive optimal hedging strategies for option portfolios hedged using an imperfectly correlated hedging asset with small fixed and/or proportional transaction costs, obtaining explicit formulae in special cases. This is of use when it is impractical to hedge using the underlying asset itself. The hedging strategy holds a position in the hedging asset whose value lies between two bounds, which are independent of the hedging asset's current value. For low absolute correlation between hedging and hedged assets, highly risk-averse investors and large portfolios, hedging strategies and option values differ significantly from their perfect market equivalents.
Download or read book Option Hedging written by and published by . This book was released on 2002 with total page 62 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis On Leland's Option Hedging Strategy with Transaction Costs by : Yonggan Zhao
Download or read book On Leland's Option Hedging Strategy with Transaction Costs written by Yonggan Zhao and published by . This book was released on 2003 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Markets with Transaction Costs by : Yuri Kabanov
Download or read book Markets with Transaction Costs written by Yuri Kabanov and published by Springer Science & Business Media. This book was released on 2009-12-04 with total page 306 pages. Available in PDF, EPUB and Kindle. Book excerpt: The book is the first monograph on this highly important subject.
Book Synopsis Feedback Effects of Dynamic Hedging Strategies in the Presence of Transaction Costs by : Elettra Agliardi
Download or read book Feedback Effects of Dynamic Hedging Strategies in the Presence of Transaction Costs written by Elettra Agliardi and published by . This book was released on 2004 with total page 13 pages. Available in PDF, EPUB and Kindle. Book excerpt: 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.
Book Synopsis Optimal Hedging Strategies for Multi-Period Guarantees in the Presence of Transaction Costs by : Stein-Erik Fleten
Download or read book Optimal Hedging Strategies for Multi-Period Guarantees in the Presence of Transaction Costs written by Stein-Erik Fleten and published by . This book was released on 2012 with total page 17 pages. Available in PDF, EPUB and Kindle. Book excerpt: Multi-period guarantees are often embedded in life insurance contracts. In this paper we consider the problem of hedging these multi-period guarantees in the presence of transaction costs. We derive the hedging strategies for the cheapest hedge portfolio for a multi-period guarantee that with certainty makes the insurance company able to meet the obligations from the insurance policies it has issued. We find that by imposing transaction costs, the insurance company reduces the rebalancing of the hedge portfolio. The cost of establishing the hedge portfolio also increases as the transaction cost increases. For the multi-period guarantee there is a rather large rebalancing of the hedge portfolio as we go from one period to the next. By introducing transaction costs we find the size of this rebalancing to be reduced. Transaction costs may therefore be one possible explanation for why we do not see the insurance companies performing a large rebalancing of their investment portfolio at the end of each year.
Book Synopsis Feedback Effects of Dynamic Hedging Strategies in the Presence of Transaction Costs by :
Download or read book Feedback Effects of Dynamic Hedging Strategies in the Presence of Transaction Costs written by and published by . This book was released on 2002 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: 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.
Author :University of Minnesota. Institute for Mathematics and Its Applications Publisher : ISBN 13 : Total Pages : pages Book Rating :4.:/5 (123 download)
Book Synopsis There is No Nontrivial Hedging Portfolio for Option Pricing with Transaction Costs by : University of Minnesota. Institute for Mathematics and Its Applications
Download or read book There is No Nontrivial Hedging Portfolio for Option Pricing with Transaction Costs written by University of Minnesota. Institute for Mathematics and Its Applications and published by . This book was released on 1994 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Analysis and Evaluation of Hedging Strategies in the Presence of Transaction Costs by : Ola Backman
Download or read book Analysis and Evaluation of Hedging Strategies in the Presence of Transaction Costs written by Ola Backman and published by . This book was released on 2001 with total page 58 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis An Analysis of Hedging Error in the Presence of Transaction Costs by : Valeria Meregalli
Download or read book An Analysis of Hedging Error in the Presence of Transaction Costs written by Valeria Meregalli and published by . This book was released on 2002 with total page 176 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Optimal Portfolio Selection with Transaction Costs and 'Event Risk' by : Hong Liu
Download or read book Optimal Portfolio Selection with Transaction Costs and 'Event Risk' written by Hong Liu and published by . This book was released on 2009 with total page 36 pages. Available in PDF, EPUB and Kindle. Book excerpt: Models with event risk (the possibility of sudden large price movements) have proven important for option pricing (e.g., Bates (1996))and optimal portfolio selection (e.g., Liu, Longstaff and Pan(2003)). However, most of the existing studies ignore transaction costs which are prevalent in almost all of the financial markets. How investors should trade in the presence of event risks and transaction costs remains an important but unanswered question. In this paper, we consider the optimal trading strategy for a CRRA investor who derives utility from terminal wealth and can continuously trade in a riskless asset and a risky asset. The risky asset, whose price follows a jump diffusion, is subject to proportional transaction costs. We show that the optimal trading strategy is to maintain the fraction of wealth invested in the risky asset between two bounds. In contrast to the case without jump risk, this fraction can jump outside the bounds which implies a discrete transaction back to the closest boundary and thus a greater transaction cost payment. We characterize the value function and provide bounds on the trading boundaries. Somewhat surprisingly, we find that an increase in transaction costs may increase trading frequency. Our numerical results suggest that event risk significantly reduces stock holdings and decreases trading frequency. We also show that the boundaries are affected not only by jump sizes but also by the uncertainty about jump sizes. Furthermore, we examine how the optimal transaction boundaries vary through time for investors with deterministic horizons.
