Barrier option hedging under constraints: A viscosity approach

Imen Bentahar and Bruno Bouchard

No 2006-022, SFB 649 Discussion Papers from Humboldt University Berlin, Collaborative Research Center 649: Economic Risk

Abstract: We study the problem of finding the minimal initial capital needed in order to hedge without risk a barrier option when the vector of proportions of wealth invested in each risky asset is constraint to lie in a closed convex domain. In the context of a Brownian diffusion model, we provide a PDE characterization of the super-hedging price. This extends the result of Broadie, Cvitanic and Soner (1998) and Cvitanic, Pham and Touzi (1999) which was obtained for plain vanilla options, and provides a natural numerical procedure for computing the corresponding super-hedging price. As a by-product, we obtain a comparison theorem for a class of parabolic PDE with relaxed Dirichet conditions involving a constraint on the gradient.

Keywords: Super-replication; barrier options; portfolio constraints; viscosity solutions (search for similar items in EconPapers)
Date: 2006
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