Optimal Portfolio Hedging with Nonlinear Derivatives and Transaction Costs

Jussi Keppo and Samu Peura

Computational Economics, 1999, vol. 13, issue 2, 117-45

Abstract: We consider the problem of dynamically hedging a fixed portfolio of assets in the presence of non-linear instruments and transaction costs, as well as constraints on feasible hedging positions. We assume an investor maximizing the expected utility of his terminal wealth over a finite holding period, and analyse the dynamic portfolio optimization problem when the trading interval is fixed. An approximate solution is obtained from a two-stage numerical procedure. The problem is first transformed into a nonlinear programming problem which utilizes simulated coefficient matrices. The nonlinear programming problem is then solved numerically using standard constrained optimization techniques. Citation Copyright 1999 by Kluwer Academic Publishers.

Date: 1999
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