Multiperiod static hedging of European options

Purba Banerjee, Srikanth Iyer and Shashi Jain

Journal of Computational Finance

Abstract: We consider the hedging of European options when the price of the underlying asset follows a single-factor Markovian framework. By working in such a setting, in 2014 Carr and Wu derived a spanning relation between a given option and a continuum of shorter-term options written on the same asset. We extend their approach to simultaneously include options over multiple short maturities. We then demonstrate a practical implementation of this extension with a finite set of shorter-term options to determine the hedging error using a Gaussian quadrature method. A wide range of experiments are performed for both the Black–Scholes model and the Merton jump-diffusion model, illustrating the comparative performance of the two methods.

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