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RESEARCH PRODUCT

European Option Pricing and Hedging with Both Fixed and Proportional Transaction Costs

Valeriy Zakamulin

subject

Stochastic controlTransaction costEconomics and EconometricsMathematical optimizationControl and OptimizationApplied MathematicsMonte Carlo methods for option pricingjel:C61Implied volatilityjel:G13jel:G11option pricing transaction costs stochastic control Markov chain approximationMicroeconomicsVariable pricingOrder (business)Valuation of optionsEconomicsAsian optionFinite difference methods for option pricing

description

Abstract In this paper we provide a systematic treatment of the utility based option pricing and hedging approach in markets with both fixed and proportional transaction costs: we extend the framework developed by Davis et al. (SIAM J. Control Optim., 31 (1993) 470) and formulate the option pricing and hedging problem. We propose and implement a numerical procedure for computing option prices and corresponding optimal hedging strategies. We present a careful analysis of the optimal hedging strategy and elaborate on important differences between the exact hedging strategy and the asymptotic hedging strategy of Whalley and Wilmott (RISK 7 (1994) 82). We provide a simulation analysis in order to compare the performance of the utility based hedging strategy against the asymptotic strategy and some other common strategies.

yearjournalcountryeditionlanguage
2003-11-21SSRN Electronic Journal
https://doi.org/10.2139/ssrn.471701