Hedging Under an Expected Loss Constraint with Small Transaction Costs

Bruno Bouchard, Ludovic Moreau and Mete Soner
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Bruno Bouchard: Université de Paris Dauphine and CREST-ENSAE
Ludovic Moreau: ETH Zurich
Mete Soner: ETH Zurich and Swiss Finance Institute

No 14-60, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

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 transaction costs is used to obtain a tractable model. A general expansion theory is developed using the dynamic programming approach. Explicit formulae are obtained in the special cases of exponential and power utility functions. As a corollary, we retrieve the asymptotics for the exponential utility indifference price.

Keywords: Expected loss constraint; hedging; transaction cost; asymptotic expansion (search for similar items in EconPapers)
JEL-codes: C61 G11 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2014-10
New Economics Papers: this item is included in nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1460

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