Recipes for hedging exotics with illiquid vanillas

Joaquin Fernandez-Tapia and Olivier Guéant

Working Papers from HAL

Abstract: In this paper, we address the question of the optimal Delta and Vega hedging of a book of exotic options when there are execution costs associated with the trading of vanilla options. In a framework where exotic options are priced using a market model (e.g. a local volatility model recalibrated continuously to vanilla option prices) and vanilla options prices are driven by a stochastic volatility model, we show that, using simple approximations, the optimal dynamic Delta and Vega hedging strategies can be computed easily using variational techniques.

Keywords: Trading and Market Microstructure (q-fin.TR); FOS: Economics and business (search for similar items in EconPapers)
Date: 2024-05-28
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Persistent link: https://EconPapers.repec.org/RePEc:hal:wpaper:hal-04590240

DOI: 10.48550/arXiv.2005.10064

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