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arXiv · 1702.01385

Perfect hedging under endogenous permanent market impacts

Masaaki Fukasawa·Mitja Stadje
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Abstract

We model a nonlinear price curve quoted in a market as the utility indifference curve of a representative liquidity supplier. As the utility function we adopt a g-expectation. In contrast to the standard framework of financial engineering, a trader is no more price taker as any trade has a permanent market impact via an effect to the supplier's inventory. The P&L of a trading strategy is written as a nonlinear stochastic integral. Under this market impact model, we introduce a completeness condition under which any derivative can be perfectly replicated by a dynamic trading strategy. In the special case of a Markovian setting the corresponding pricing and hedging can be done by solving a semi-linear PDE.

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Masaaki Fukasawa, Mitja Stadje. 2017-02-05. Perfect hedging under endogenous permanent market impacts. https://arxiv.org/abs/1702.01385

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