Minimax Hedging Strategy

M A Howe, B Rustem and M J P Selby

Computational Economics, 1994, vol. 7, issue 4, 245-75

Abstract: We present several variants of a robust risk management strategy based on minimax for the writer of a European call option on a stock and show that it performs at least as well as the standard hedging strategy, delta hedging. When using the minimax strategy, the hedger specifies a worst case scenario in terms of the price of the underlying stock. The minimax strategy recommends the number of shares in the underlying stock the hedger should hold in order to minimize the hedging error against the worst case occurring. The minimax hedging error may correspond to an extreme point of the price range being considered or to a mid-range solution. Simulation and empirical results suggest that the minimax strategy is particularly powerful for hedging the risk of writing an option when the price of the underlying stock is both highly volatile and crosses over the exercise frequently. Citation Copyright 1994 by Kluwer Academic Publishers.

Date: 1994
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