Minimizing expected loss of hedging in incomplete and constrained markets

Authors
Citation
J. Cvitanic, Minimizing expected loss of hedging in incomplete and constrained markets, SIAM J CON, 38(4), 2000, pp. 1050-1066
Citations number
18
Categorie Soggetti
Mathematics,"Engineering Mathematics
Journal title
SIAM JOURNAL ON CONTROL AND OPTIMIZATION
ISSN journal
03630129 → ACNP
Volume
38
Issue
4
Year of publication
2000
Pages
1050 - 1066
Database
ISI
SICI code
0363-0129(20000524)38:4<1050:MELOHI>2.0.ZU;2-Y
Abstract
We study the problem of minimizing the expected discounted loss E[e(-)integral(o)(T) (r(u)du) (C - X-x,X-pi(T))(+)] when hedging a liability C at time t = T, using an admissible portfolio str ategy pi(.) and starting with initial wealth x. The existence of an optimal solution is established in the context of continuous-time Ito process inco mplete market models, by studying an appropriate dual problem. It is shown that the optimal strategy is of the form of a knock-out option with payoff C, where the domain of the knock-out depends on the value of the optimal du al variable. We also discuss a dynamic measure for the risk associated with the liability C, defined as the supremum over different scenarios of the m inimal expected loss of hedging C.