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Optimal Dynamic Hedging in Incomplete Futures Markets

Author

Listed:
  • Abraham Lioui

    (University of Paris-I Sorbonne and Bar Ilan University)

  • Pascal Nguyen Duc Trong

    (ESSEC and Université du Littoral)

  • Patrice Poncet

    (University of Paris-I Sorbonne and ESSEC, Avenue Bernard Hirsch, B.P. 105, 95021, Cergy-Pontoise Cedex, France)

Abstract

This article derives optimal hedging demands for futures contracts from an investor who cannot freely trade his portfolio of primitive assets in the context of either a CARA or a logarithmic utility function. Existing futures contracts are not numerous enough to complete the market. In addition, in the case of CARA, the nonnegativity constraint on wealth is binding, and the optimal hedging demands are not identical to those that would be derived if the constraint were ignored. Fictitiously completing the market, we can characterize the optimal hedging demands for futures contracts. Closed-form solutions exist in the logarithmic case but not in the CARA case, since then a put (insurance) written on his wealth is implicitly bought by the investor. Although solutions are formally similar to those that obtain under complete markets, incompleteness leads in fact to second-best optima. The Geneva Papers on Risk and Insurance Theory (1996) 21, 103–122. doi:10.1007/BF00949052

Suggested Citation

  • Abraham Lioui & Pascal Nguyen Duc Trong & Patrice Poncet, 1996. "Optimal Dynamic Hedging in Incomplete Futures Markets," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 21(1), pages 103-122, June.
    • Handle: RePEc:pal:genrir:v:21:y:1996:i:1:p:103-122
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    Cited by:

    1. Mellios, Constantin & Six, Pierre & Lai, Anh Ngoc, 2016. "Dynamic speculation and hedging in commodity futures markets with a stochastic convenience yield," European Journal of Operational Research, Elsevier, vol. 250(2), pages 493-504.

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