IDEAS home Printed from https://ideas.repec.org/a/now/fnttom/0200000102.html
   My bibliography  Save this article

Quadratic Hedging and Optimization of Option Exercise Policies

Author

Listed:
  • Nicola Secomandi

Abstract

Quadratic hedging of option payoffs generates the variance optimal martingale measure. When an option features an exercise policy and its cash flows are hedged according to this approach, it may be tempting to optimize such a policy under this measure. Because the variance optimal martingale measure may not be an equivalent probability measure, focusing on American options we show that the resulting exercise policy may be unappealing. This drawback can sometimes be remedied by imposing time consistency on exercise policies, but in general persists even in this case, which compounds the familiar issue that valuing an option using this measure may not result in an arbitrage free value. An alternative and known approach bypasses both of these pitfalls by optimizing option exercise policies under any given equivalent martingale measure and anchoring quadratic hedging to the resulting value of this policy. Additional research may assess on realistic applications the magnitude of the limitations associated with optimizing option exercise policies based on the variance optimal martingale measure.

Suggested Citation

  • Nicola Secomandi, 2022. "Quadratic Hedging and Optimization of Option Exercise Policies," Foundations and Trends(R) in Technology, Information and Operations Management, now publishers, vol. 15(3), pages 204-224, July.
    • Handle: RePEc:now:fnttom:0200000102
    DOI: 10.1561/0200000102
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.1561/0200000102
    Download Restriction: no
    File URL: https://libkey.io/10.1561/0200000102?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. de Zegher, Joann F. & Iancu, Dan A. & Plambeck, Erica, 2018. "Sustaining Rainforests and Smallholders by Eliminating Payment Delay in a Commodity Supply Chain--It Takes a Village," Research Papers 3684, Stanford University, Graduate School of Business.
    2. Kirman, Alan P & Sobel, Matthew J, 1974. "Dynamic Oligopoly with Inventories," Econometrica, Econometric Society, vol. 42(2), pages 279-287, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Secomandi, Nicola, 2022. "Quadratic hedging of risk neutral values," Energy Economics, Elsevier, vol. 112(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Hamed Ghoddusi, 2022. "Coordination Problems in Platform Markets Under Uncertainty," Foundations and Trends(R) in Technology, Information and Operations Management, now publishers, vol. 15(3), pages 282-306, July.
    2. Zhi Chen & Jussi Keppo, 2022. "Data Sharing in Innovations," Foundations and Trends(R) in Technology, Information and Operations Management, now publishers, vol. 15(3), pages 266-281, July.
    3. Matthew J. Sobel, 2022. "Value Games," Foundations and Trends(R) in Technology, Information and Operations Management, now publishers, vol. 15(3), pages 307-324, July.
    4. Paolo Guiotto & Andrea Roncoroni & Roméo Tédongap, 2022. "Operations Revenue Insurance," Foundations and Trends(R) in Technology, Information and Operations Management, now publishers, vol. 15(3), pages 225-246, July.
    5. Fasheng Xu & Xiaomeng Guo & Guang Xiao & Fuqiang Zhang, 2022. "Crowdfunding Adoption in the Presence of Word-of-Mouth Communication," Foundations and Trends(R) in Technology, Information and Operations Management, now publishers, vol. 15(3), pages 247-265, July.
    6. Steinmetz, Alexander, 2010. "Price and inventory dynamics in an oligopoly industry: A framework for commodity markets," W.E.P. - Würzburg Economic Papers 82, University of Würzburg, Department of Economics.
    7. MITRAILLE Sébastien & MOREAUX Michel, 2007. "Inventories and Endogenous Stackelberg Hierarchy in Two-period Cournot Oligopoly," LERNA Working Papers 07.02.223, LERNA, University of Toulouse.
    8. Wei Shi Lim, 2009. "Overselling in a Competitive Environment: Boon or Bane?," Marketing Science, INFORMS, vol. 28(6), pages 1129-1143, 11-12.
    9. Vettas, Nikolaos & Biglaiser, Gary, 2004. "Dynamic Price Competition with Capacity Constraints and Strategic Buyers," CEPR Discussion Papers 4315, C.E.P.R. Discussion Papers.
    10. Sébastien Mitraille & Michel Moreaux, 2013. "Inventories and Endogenous Stackelberg Leadership in Two‐Period Cournot Oligopoly," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 22(4), pages 852-874, December.
    11. Jean-Paul Chavas, 2008. "On Storage Behavior Under Imperfect Competition, with Application to the American Cheese Market," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 33(4), pages 325-339, December.
    12. S. D. Deshmukh & Wayne Winston, 1976. "A Zero-Sum Stochastic Game Model of Duopoly," Discussion Papers 230, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    13. Matthew J. Sobel & Wei Wei, 2010. "Myopic Solutions of Homogeneous Sequential Decision Processes," Operations Research, INFORMS, vol. 58(4-part-2), pages 1235-1246, August.
    14. Halkos, George, 2009. "A Differential game approach in the case of a polluting oligopoly," MPRA Paper 23742, University Library of Munich, Germany.
    15. Rodney P. Parker & Roman Kapuściński, 2011. "Managing a Noncooperative Supply Chain with Limited Capacity," Operations Research, INFORMS, vol. 59(4), pages 866-881, August.
    16. Fernando Bernstein & Awi Federgruen, 2004. "A General Equilibrium Model for Industries with Price and Service Competition," Operations Research, INFORMS, vol. 52(6), pages 868-886, December.
    17. Dubovik, Andrei & Parakhonyak, Alexei, 2014. "Drugs, guns, and targeted competition," Games and Economic Behavior, Elsevier, vol. 87(C), pages 497-507.
    18. Edmond Baranes & François Mirabel & Jean-Christophe Poudou, 2007. "Concurrence et stockage stratégique sur le marché gazier," Economie & Prévision, La Documentation Française, vol. 0(2), pages 25-40.
    19. Karen Donohue & Özalp Özer, 2020. "Behavioral Operations: Past, Present, and Future," Manufacturing & Service Operations Management, INFORMS, vol. 22(1), pages 191-202, January.
    20. Stronzik, Marcus & Rammerstorfer, Margarethe & Neumann, Anne, 2009. "Does the European natural gas market pass the competitive benchmark of the theory of storage? Indirect tests for three major trading points," Energy Policy, Elsevier, vol. 37(12), pages 5432-5439, December.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:now:fnttom:0200000102. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Lucy Wiseman (email available below). General contact details of provider: http://www.nowpublishers.com/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.