Option Pricing and Hedging with Small Transaction Costs

Jan Kallsen and Johannes Muhle-Karbe
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Jan Kallsen: Munich University of Technology
Johannes Muhle-Karbe: University of Michigan at Ann Arbor

No 12-30, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: An investor with constant absolute risk aversion trades a risky asset with general Itôdynamics, in the presence of small proportional transaction costs. In this setting, we formally derive a leading-order optimal trading policy and the associated welfare, expressed in terms of the local dynamics of the frictionless optimizer. By applying these results in the presence of a random endowment, we obtain asymptotic formulas for utility indifference prices and hedging strategies in the presence of small transaction costs.

Keywords: transaction costs; indifference pricing and hedging; exponential utility; asymptotics (search for similar items in EconPapers)
JEL-codes: G11 G13 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2012-09
New Economics Papers: this item is included in nep-cfn and nep-upt
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1230

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