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arXiv · 1506.02074

Optimal Static Quadratic Hedging

Tim Leung·Matthew Lorig
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Abstract

We propose a flexible framework for hedging a contingent claim by holding static positions in vanilla European calls, puts, bonds, and forwards. A model-free expression is derived for the optimal static hedging strategy that minimizes the expected squared hedging error subject to a cost constraint. The optimal hedge involves computing a number of expectations that reflect the dependence among the contingent claim and the hedging assets. We provide a general method for approximating these expectations analytically in a general Markov diffusion market. To illustrate the versatility of our approach, we present several numerical examples, including hedging path-dependent options and options written on a correlated asset.

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Tim Leung, Matthew Lorig. 2015-06-05. Optimal Static Quadratic Hedging. https://arxiv.org/abs/1506.02074

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