Option Pricing and Hedging with Small Transaction Costs

Jan Kallsen and Johannes Muhle-Karbe

Papers from arXiv.org

Abstract: An investor with constant absolute risk aversion trades a risky asset with general It\^o-dynamics, in the presence of small proportional transaction costs. In this setting, we formally derive a leading-order optimal trading policy and the associated welfare, expressed in terms of the local dynamics of the frictionless optimizer. By applying these results in the presence of a random endowment, we obtain asymptotic formulas for utility indifference prices and hedging strategies in the presence of small transaction costs.

Date: 2012-09, Revised 2012-12
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Citations: View citations in EconPapers (2)

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