On the choice between two delta-hedging strategies

Liang Hong ()
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Liang Hong: Robert Morris University

Decisions in Economics and Finance, 2016, vol. 39, issue 1, No 3, 69-80

Abstract: Abstract This paper studies the choice between two popular hedging strategies by assuming that the hedge position (delta) follows a Markov chain with boundary conditions. We give the formula for long-run cost per unit time under two different cost structures: (I) a fixed transaction cost and (II) a non-fixed transaction cost. Then, we consider the case where the hedge position follows a random walk; we show that (i) re-balancing delta to the initial position is always more cost-efficient than re-balancing it to the edge for a fixed transaction cost; (ii) under certain conditions, re-balancing delta to the initial position is less cost-efficient than re-balancing it to the edge for a non-fixed transaction cost. In addition, we quantify the magnitude of the efficiency in both cases.

Keywords: Cost of hedging; Re-balancing; Markov chain; Random walk; Fixed transaction cost; Non-fixed transaction cost (search for similar items in EconPapers)
JEL-codes: C02 G22 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (1)

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DOI: 10.1007/s10203-016-0172-6

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