Implicit Hedging and Liquidity Costs of Structured Products

Kujtim Avdiu and Stephan Unger ()
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Kujtim Avdiu: Department of Statstics, Oesterreichische Nationalbank (OeNB), Otto-Wagner-Platz 3, 1090 Vienna, Austria
Stephan Unger: Department of Economics & Business, Saint Anselm College, Goffstown, NH 03102, USA

JRFM, 2023, vol. 16, issue 9, 1-14

Abstract: This article analyzes the implicit hedging and liquidity costs of structured equity products offered by various financial institutions. We replicate several payoffs of structured products, compare the calculated fair values based on the Heston model as well as geometric Brownian motion, using various optimization techniques, and compare their fair values with the historic prices traded in the market. We find that implicit hedging costs range between 0.9% and 2.9% markup on the fair value, where we find the underlying market volatility to be the relevant driver of this range for complex structures, while market liquidity can be extracted as the only driver of markups for simple structures with no hedging requirements.

Keywords: pricing; Heston model; hedging costs; structured products; optimization (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2023
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