Effectiveness of Hedging Strategies under Model Misspecification and Trading Restrictions

Antje Mahayni ()
Additional contact information
Antje Mahayni: Department of Statistics, University of Bonn, Adenauerallee 24–42, 53113 Bonn, Germany

International Journal of Theoretical and Applied Finance (IJTAF), 2003, vol. 06, issue 05, 521-552

Abstract: The following paper focuses on the incompleteness arising from model misspecification combined with trading restrictions. While asset price dynamics are assumed to be continuous time processes, the hedging of contingent claims occurs in discrete time. The trading strategies under consideration are understood to be self-financing with respect to an assumed model which may deviate from the "true" model, thus associating duplication costs with respect to a contingent claim to be hedged. Based on the robustness result of Gaussian hedging strategies, which states that a superhedge is achieved for convex payoff-functions if the "true" asset price volatility is dominated by the assumed one, the error of time discretising these strategies is analysed. It turns out that the time discretisation of Gaussian hedges gives rise to a duplication bias caused by asset price trends, which can be avoided by discretising the hedging model instead of discretising the hedging strategies. Additionally it is shown, that on the one hand binomial strategies incorporate similar robustness features as Gaussian hedges. On the other hand, the distribution of the cost process associated with the binomial hedge coincides, in the limit, with the distribution of the cost process associated with the Gaussian hedge. Together, the last results yield a strong argument in favour of discretising the hedge model instead of time-discretising the strategies.

Keywords: Hedging-strategies; superhedging; model misspecification; trading restrictions; change of measure (search for similar items in EconPapers)
Date: 2003
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
http://www.worldscientific.com/doi/abs/10.1142/S0219024903001967
Access to full text is restricted to subscribers

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:ijtafx:v:06:y:2003:i:05:n:s0219024903001967

Ordering information: This journal article can be ordered from

DOI: 10.1142/S0219024903001967

Access Statistics for this article

International Journal of Theoretical and Applied Finance (IJTAF) is currently edited by L P Hughston

More articles in International Journal of Theoretical and Applied Finance (IJTAF) from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().