EFFICIENT HEDGING OF PATH–DEPENDENT OPTIONS

Adam W. Kolkiewicz ()
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Adam W. Kolkiewicz: Department of Statistics and Actuarial Science, University of Waterloo, Waterloo, Canada

International Journal of Theoretical and Applied Finance (IJTAF), 2016, vol. 19, issue 05, 1-27

Abstract: In this paper, we propose a novel method of hedging path-dependent options in a discrete-time setup. Assuming that prices are given by the Black–Scholes model, we first describe the residual risk when hedging a path-dependent option using only an European option. Then, for a fixed hedging interval, we find the hedging option that minimizes the shortfall risk, which we define as the expectation of the shortfall weighted by some loss function. We illustrate the method using Asian options, but the methodology is applicable to other path-dependent contacts.

Keywords: Hedging; shortfall risk; path-dependent options (search for similar items in EconPapers)
Date: 2016
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DOI: 10.1142/S0219024916500321

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