Option pricing and hedging with minimum expected shortfall

Benoit Pochard and Jean-Philippe Bouchaud
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Benoit Pochard: Centre de mathematiques appliquees, Ecole Polytechnique, Palaiseau, FRANCE
Jean-Philippe Bouchaud: Science & Finance, Capital Fund Management

No 500029, Science & Finance (CFM) working paper archive from Science & Finance, Capital Fund Management

Abstract: We propose a versatile Monte-Carlo method for pricing and hedging options when markets are inco;plete, for an arbitrary risk criterion (chosen here to be the expected shortfall), for a large class of stochastic processes, and in the presence of transaction costs. We illustrate the method on plain vanilla options when the price returns follow a Student-t distribution. We show that in the presence of fat tails, our strategy allows to significantly reduce extreme risks, and generically leads to low Gamma hedging. Similarly, the inclusion of transaction costs reduces the Gamma of the optimal strategy.

JEL-codes: G10 (search for similar items in EconPapers)
Date: 2003-08
New Economics Papers: this item is included in nep-cfn, nep-fin and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:sfi:sfiwpa:500029

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