Year: 2008
Type: article
Abstract: We examine optimal hedging of a claim on a non-traded asset, using a\ncorrelated traded asset, when one does not know with certainty the\nvalues of the asset price drifts. In this partial information setting,\nthe uncertain parameters are considered as random variables. We filter\nthe drifts from price observations, updating a chosen prior\ndistribution. The result is an effective full information model with\nrandom drift parameters. Using a dual approach, we derive\nrepresentations for the indifference price and optimal hedging\nstrategy, with exponential utility. Using the marginal utility-based\nprice as an approximation to the indifference price, analytic formulae\nfor the optimal hedge are possible, and this allows a simulation study\nof the optimal hedging program to be carried out. The results indicate\nimproved hedging performance relative to a Black-Scholes strategy\nwhich takes the correlation as perfect, and also relative to a\nutility-based hedging program which does not incorporate learning.
Author: Monoyios, M
Institution: University of Oxford
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W175015393