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The Best Hedging Strategy In The Presence Of Transaction Costs

Author

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  • VALERI ZAKAMOULINE

    (Faculty of Economics, University of Agder, Service Box 422, 4604 Kristiansand, Norway)

Abstract

Considerable theoretical work has been devoted to the problem of option pricing and hedging with transaction costs. A variety of methods have been suggested and are currently being used for dynamic hedging of options in the presence of transaction costs. However, very little was done on the subject of an empirical comparison of different methods for option hedging with transaction costs. In a few existing studies the different methods are compared by studying their empirical performances in hedging only a plain-vanilla short call option. The reader is tempted to assume that the ranking of the different methods for hedging any kind of option remains the same as that for a vanilla call. The main goal of this paper is to show that the ranking of the alternative hedging strategies depends crucially on the type of the option position being hedged and the risk preferences of the hedger. In addition, we present and implement a simple optimization method that, in some cases, improves considerably the performance of some hedging strategies.

Suggested Citation

  • Valeri Zakamouline, 2009. "The Best Hedging Strategy In The Presence Of Transaction Costs," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(06), pages 833-860.
    • Handle: RePEc:wsi:ijtafx:v:12:y:2009:i:06:n:s0219024909005488
    DOI: 10.1142/S0219024909005488
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    Cited by:

    1. Lin, X. Sheldon & Wu, Panpan & Wang, Xiao, 2016. "Move-based hedging of variable annuities: A semi-analytic approach," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 40-49.
    2. Matthias Pelster, 2014. "Implications of financial transaction costs on the real economy: A note," Contemporary Economics, University of Economics and Human Sciences in Warsaw., vol. 8(1), March.
    3. Augusto Blanc-Blocquel & Luis Ortiz-Gracia & Rodolfo Oviedo, 2023. "Hedging At-the-money Digital Options Near Maturity," Methodology and Computing in Applied Probability, Springer, vol. 25(1), pages 1-18, March.
    4. Yuan Hu & W. Brent Lindquist & Svetlozar T. Rachev & Frank J. Fabozzi, 2023. "Option pricing using a skew random walk pricing tree," Papers 2303.17014, arXiv.org.

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