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On The Numerical Aspects Of Optimal Option Hedging With Transaction Costs

Author

Listed:
  • NORMAN JOSEPHY

    (Department of Mathematical Sciences, Bentley University, 175 Forest Street, Waltham, MA 02452-4705, USA)

  • LUCIA KIMBALL

    (Department of Mathematical Sciences, Bentley University, 175 Forest Street, Waltham, MA 02452-4705, USA)

  • VICTORIA STEBLOVSKAYA

    (Department of Mathematical Sciences, Bentley University, 175 Forest Street, Waltham, MA 02452-4705, USA)

Abstract

We present a numerical study of non-self-financing hedging of European options under proportional transaction costs. We describe an algorithmic approach based on a discrete time financial market model that extends the classical binomial model. We review the analytical basis for our algorithm and present a variety of empirical results using real market data. The performance of the algorithm is evaluated by comparing to a Black–Scholes delta hedge with transaction costs incorporated. We also evaluate the impact of recalibrating the hedging strategy one or more times during the life of the option using the most recent market data. These results are compared to a recalibrated Black–Scholes delta hedge modified for transaction costs.

Suggested Citation

  • Norman Josephy & Lucia Kimball & Victoria Steblovskaya, 2017. "On The Numerical Aspects Of Optimal Option Hedging With Transaction Costs," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(01), pages 1-22, February.
    • Handle: RePEc:wsi:ijtafx:v:20:y:2017:i:01:n:s0219024917500029
    DOI: 10.1142/S0219024917500029
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    References listed on IDEAS

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    1. Leland, Hayne E, 1985. "Option Pricing and Replication with Transactions Costs," Journal of Finance, American Finance Association, vol. 40(5), pages 1283-1301, December.
    2. Norman Josephy & Lucia Kimball & Victoria Steblovskaya, 2016. "Optimal hedging in an extended binomial market under transaction costs," Quantitative Finance, Taylor & Francis Journals, vol. 16(5), pages 763-776, May.
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