Gerer, Johannes and Dorfleitner, Gregor (2018) Optimal discrete hedging of American options using an integrated approach to options with complex embedded decisions. REVIEW OF DERIVATIVES RESEARCH, 21 (2). pp. 175-199. ISSN 1380-6645, 1573-7144
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In order to solve the problem of optimal discrete hedging of American options, this paper utilizes an integrated approach in which the writer's decisions (including hedging decisions) and the holder's decisions are treated on equal footing. From basic principles expressed in the language of acceptance sets we derive a general pricing and hedging formula and apply it to American options. The result combines the important aspects of the problem into one price. It finds the optimal compromise between risk reduction and transaction costs, i.e. optimally placed rebalancing times. Moreover, it accounts for the interplay between the early exercise and hedging decisions. We then perform a numerical calculation to compare the price of an agent who has exponential preferences and uses our method of optimal hedging against a delta hedger. The results show that the optimal hedging strategy is influenced by the early exercise boundary and that the worst case holder behavior for a sub-optimal hedger significantly deviates from the classical Black-Scholes exercise boundary.
| Item Type: | Article |
|---|---|
| Uncontrolled Keywords: | PROPORTIONAL TRANSACTION COSTS; MARKETS; Transaction costs; Early exercise; Discrete hedging; American option; Embedded decisions; Good-deal bounds |
| Subjects: | 300 Social sciences > 330 Economics |
| Divisions: | Business, Economics and Information Systems > Institut für Betriebswirtschaftslehre Business, Economics and Information Systems > Institut für Betriebswirtschaftslehre > Lehrstuhl für Finanzierung (Prof. Dr. Gregor Dorfleitner) |
| Depositing User: | Dr. Gernot Deinzer |
| Date Deposited: | 20 Feb 2020 08:21 |
| Last Modified: | 20 Feb 2020 08:21 |
| URI: | https://pred.uni-regensburg.de/id/eprint/14359 |
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