Replication Methods in the Pricing and Hedging of Barrier Options

Tichý Tomáš

Czech Journal of Economics and Finance (Finance a uver), 2004, vol. 54, issue 7-8, 305-324

Abstract: This paper considers various options replication methods. Firstly, a specific type of barrier option, an up-and-out call, is considered. Other barrier options are briefly also described, and various types of barriers are considered. Secondly, a general definition of replication methods is provided. Two methods are thus examined in detail: The first one, based on ever-changing positions in replicating portfolio, is referred to as a dynamic replication method. The second one is denoted as a static replication method ? its aim is to create a static basket of simple assets that will replicate the option payoff. However, in the real world it is difficult to attain perfect replication; therefore, the expected replication error of both methods is studied via simulation technique.

Keywords: Options; barrier options; replication methods; dynamic and static replication; replication error (search for similar items in EconPapers)
JEL-codes: C15 C61 D81 G11 G13 G20 (search for similar items in EconPapers)
Date: 2004
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Persistent link: https://EconPapers.repec.org/RePEc:fau:fauart:v:54:y:2004:i:7-8:p:305-324

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