Optimal Hedging when the Underlying Asset Follows a Regime-switching Markov Process

Pascal François, Geneviève Gauthier and Frédéric Godin

Cahiers de recherche from CIRPEE

Abstract: We develop a flexible discrete-time hedging methodology that minimizes the expected value of any desired penalty function of the hedging error within a general regime-switching framework. A numerical algorithm based on backward recursion allows for the sequential construction of an optimal hedging strategy. Numerical experiments comparing this and other methodologies show a relative expected penalty reduction ranging between 0.9% and 12.6% with respect to the best benchmark.

Keywords: Dynamic programming; hedging; risk management; regime switching (search for similar items in EconPapers)
JEL-codes: C61 G32 (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-ore and nep-rmg
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