ON THE NUMERICAL ASPECTS OF OPTIMAL OPTION HEDGING WITH TRANSACTION COSTS

Norman Josephy, Lucia Kimball () and Victoria Steblovskaya ()
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Norman Josephy: Department of Mathematical Sciences, Bentley University, 175 Forest Street, Waltham, MA 02452-4705, USA
Lucia Kimball: Department of Mathematical Sciences, Bentley University, 175 Forest Street, Waltham, MA 02452-4705, USA
Victoria Steblovskaya: Department of Mathematical Sciences, Bentley University, 175 Forest Street, Waltham, MA 02452-4705, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2017, vol. 20, issue 01, 1-22

Abstract: We present a numerical study of non-self-financing hedging of European options under proportional transaction costs. We describe an algorithmic approach based on a discrete time financial market model that extends the classical binomial model. We review the analytical basis for our algorithm and present a variety of empirical results using real market data. The performance of the algorithm is evaluated by comparing to a Black–Scholes delta hedge with transaction costs incorporated. We also evaluate the impact of recalibrating the hedging strategy one or more times during the life of the option using the most recent market data. These results are compared to a recalibrated Black–Scholes delta hedge modified for transaction costs.

Keywords: Extended binomial model; proportional transaction costs; non-self-financing hedging (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1142/S0219024917500029

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