Hedging large risks reduces the transaction costs

Farhat Selmi and Jean-Philippe Bouchaud
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Jean-Philippe Bouchaud: Science & Finance, Capital Fund Management

No 500033, Science & Finance (CFM) working paper archive from Science & Finance, Capital Fund Management

Abstract: As soon as one accepts to abandon the zero-risk paradigm of Black-Scholes, very interesting issues concerning risk control arise because different definitions of the risk become unequivalent. Optimal hedges then depend on the quantity one wishes to minimize. We show that a definition of the risk more sensitive to the extreme events generically leads to a decrease both of the probability of extreme losses and of the sensitivity of the hedge on the price of the underlying (the `Gamma'). Therefore, the transaction costs and the impact of hedging on the price dynamics of the underlying are reduced.

JEL-codes: G10 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn and nep-fin
Date: 2000-05
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