Static Hedging of Barrier Options under General Asset Dynamics: Unification and Application

Morten Nalholm
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Morten Nalholm: Department of Applied Mathematics and Statistics, Institute for Mathematical Sciences, University of Copenhagen

No 2005/08, FRU Working Papers from University of Copenhagen. Department of Economics. Finance Research Unit

Abstract: A new method for static hedging of barrier options under general asset dynamics is introduced. The method unifies previous approaches and nests their extensions. Using a finite set of hedge instruments the method is directly implementable and it is shown how to operationalize the hedge in a jump-diffusion model with correlated stochastic volatility. The performance of the hedge is thoroughly studied and generic sources of hedge errors are addressed.

Pages: 30 pages
Date: 2005-11
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