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Small Transaction Cost Asymptotics and Dynamic Claudio Albanese Stathis Tompaidis
 

Summary: Small Transaction Cost Asymptotics and Dynamic
Hedging
Claudio Albanese Stathis Tompaidis
ABSTRACT
Transaction costs are one of the major impediments to the implementation of dy-
namic hedging strategies. We consider an alternative to utility maximization, similar to
the "good-deal" pricing framework in incomplete markets. We perform a dynamic risk-
reward analysis for a family of non-self-financing strategies of practical importance: de-
terministic time hedging; i.e., hedging at predetermined, fixed, times. In the limit of small
relative transaction costs, we carry out the asymptotic analysis and find that transaction
costs affect the hedge ratios and that the time between trades is related in a simple way to
the local sensitivities of the replication target.
Acknowledgments: We would like to acknowledge the helpful comments and suggestions of seminar parti-
cipants at the University of Toronto, the Fields Institute, Universit´e de Rennes I, Universit´e de Paris VI, University
of Texas at Austin, Swiss Federal Institutes of Technology in Z¨urich and Lausanne. We would also like to thank
Peter Bossaerts, Peter Carr, Patrick Jaillet, Ehud Ronn, and Klaus Toft, for discussions and suggestions.
Department of Mathematics, Imperial College, London, SW7 2AZ, United Kingdom,
claudio.albanese@imperial.ac.uk
MSIS Department, McCombs School of Business, University of Texas at Austin, 1 University Station,
B6500, Austin, TX 78712-1175, stathis.tompaidis@mccombs.utexas.edu

  

Source: Albanese, Claudio - Department of Mathematics, King's College London

 

Collections: Mathematics