Optimal market completion through financial derivatives with applications to volatility risk

Matt Davison, Marcos Escobar-Anel and Yichen Zhu
Authors registered in the RePEc Author Service: Marcos Escobar Anel ()

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Abstract: This paper investigates the optimal choices of financial derivatives to complete a financial market in the framework of stochastic volatility (SV) models. We introduce an efficient and accurate simulation-based method, applicable to generalized diffusion models, to approximate the optimal derivatives-based portfolio strategy. We build upon the double optimization approach (i.e. expected utility maximization and risk exposure minimization) proposed in Escobar-Anel et al. (2022); demonstrating that strangle options are the best choices for market completion within equity options. Furthermore, we explore the benefit of using volatility index derivatives and conclude that they could be more convenient substitutes when only long-term maturity equity options are available.

Date: 2022-02
New Economics Papers: this item is included in nep-ban, nep-cmp, nep-ore, nep-rmg and nep-upt
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http://arxiv.org/pdf/2202.08148 Latest version (application/pdf)

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Journal Article: Optimal Market Completion through Financial Derivatives with Applications to Volatility Risk (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2202.08148

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