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Optimal Portfolio Hedging with Nonlinear Derivatives and Transaction Costs

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  • Keppo, Jussi
  • Peura, Samu

Abstract

We consider the problem of dynamically hedging a fixed portfolio of assets in the presence of non-linear instruments and transaction costs, as well as constraints on feasible hedging positions. We assume an investor maximizing the expected utility of his terminal wealth over a finite holding period, and analyse the dynamic portfolio optimization problem when the trading interval is fixed. An approximate solution is obtained from a two-stage numerical procedure. The problem is first transformed into a nonlinear programming problem which utilizes simulated coefficient matrices. The nonlinear programming problem is then solved numerically using standard constrained optimization techniques. Citation Copyright 1999 by Kluwer Academic Publishers.

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  • Keppo, Jussi & Peura, Samu, 1999. "Optimal Portfolio Hedging with Nonlinear Derivatives and Transaction Costs," Computational Economics, Springer;Society for Computational Economics, vol. 13(2), pages 117-145, April.
    • Handle: RePEc:kap:compec:v:13:y:1999:i:2:p:117-45
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    Cited by:

    1. Vehvilainen, Iivo & Keppo, Jussi, 2003. "Managing electricity market price risk," European Journal of Operational Research, Elsevier, vol. 145(1), pages 136-147, February.

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