Asymptotic replication with modified volatility under small transaction costs

Jiatu Cai () and Masaaki Fukasawa ()
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Jiatu Cai: Université Paris Diderot
Masaaki Fukasawa: Osaka University

Finance and Stochastics, 2016, vol. 20, issue 2, No 4, 431 pages

Abstract: Abstract We consider the dynamic hedging of a European option under a general local volatility model with small proportional transaction costs. Extending the approach of Leland, we introduce a class of continuous strategies of finite cost that asymptotically (super-)replicate the payoff. An associated central limit theorem for the hedging error is proved. We also obtain an explicit trading strategy minimizing the asymptotic error variance.

Keywords: Leland’s strategy; Proportional transaction costs; Singular control; Homogenization; Central limit theorem; 91G99; 60F99 (search for similar items in EconPapers)
JEL-codes: C61 G13 (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/s00780-016-0294-2

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