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Efficient analytic approximation of the optimal hedging strategy for a European call option with transaction costs

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  • Valeri zakamouline

Abstract

One of the most successful approaches to option hedging with transaction costs is the utility-based approach, pioneered by Hodges and Neuberger [Rev. Futures Markets, 1989, 8, 222-239]. Judging against the best possible trade-off between the risk and the costs of a hedging strategy, this approach seems to achieve excellent empirical performance. However, this approach has one major drawback that prevents the broad application of this approach in practice: the lack of a closed-form solution. We overcome this drawback by presenting a simple yet efficient analytic approximation of the solution. We provide an empirical testing of our approximation strategy against the asymptotic and some other well-known strategies and find that our strategy outperforms all the others.

Suggested Citation

  • Valeri zakamouline, 2006. "Efficient analytic approximation of the optimal hedging strategy for a European call option with transaction costs," Quantitative Finance, Taylor & Francis Journals, vol. 6(5), pages 435-445.
    • Handle: RePEc:taf:quantf:v:6:y:2006:i:5:p:435-445
    DOI: 10.1080/14697680600724809
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    Cited by:

    1. Michèle Breton & Frédéric Godin, 2017. "Global Hedging through Post-Decision State Variables," JRFM, MDPI, vol. 10(3), pages 1-6, August.
    2. Bandi, Chaithanya & Bertsimas, Dimitris, 2014. "Robust option pricing," European Journal of Operational Research, Elsevier, vol. 239(3), pages 842-853.
    3. Zakamulin, Valeriy & Giner, Javier, 2023. "Optimal trend-following with transaction costs," International Review of Financial Analysis, Elsevier, vol. 90(C).
    4. Terje Lensberg & Klaus Reiner Schenk-Hopp'e, 2013. "Hedging without sweat: a genetic programming approach," Papers 1305.6762, arXiv.org.

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