SIMPLIFIED HEDGE FOR PATH-DEPENDENT DERIVATIVES

Carole Bernard and Junsen Tang ()
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Carole Bernard: Department of Accounting, Law and Finance, Grenoble Ecole de Management, 12 Rue Pierre Sémard, 38003 Grenoble, France
Junsen Tang: Department of Statistics and Actuarial Science, University of Waterloo, 200 University Avenue West, Waterloo, ON, Canada N2L 3G1, Canada

International Journal of Theoretical and Applied Finance (IJTAF), 2016, vol. 19, issue 07, 1-32

Abstract: Path-dependent derivatives are typically difficult to hedge. Traditional dynamic delta hedging does not perform well because of the difficulty to evaluate the Greeks and the high cost of constantly rebalancing. We propose to price and hedge path-dependent derivatives by constructing simplified alternatives that preserve certain distributional properties of their terminal payoffs, and that can be hedged by semi-static replication. The method is illustrated by a geometric Asian option and by a lookback option in the Black–Scholes setting, for which explicit forms of the simplified alternatives exist. Extensions to a Lévy market and to a Heston stochastic volatility model are discussed as well.

Keywords: Derivatives pricing; derivatives hedging; path-dependent derivatives; semi-static replication (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (3)

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DOI: 10.1142/S021902491650045X

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