Mean-variance hedging with uncertain trade execution

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Abstract

This paper studies a hedging problem of a contingent claim in a discrete time model. The contingent claim is hedged by one illiquid risky asset and the hedging error is measured by a quadratic criterion. In our model, trade does not always succeed and then trade times are not only discrete, but also random. The uncertainty of trade execution represents the liquidity risk. First we find an optimal hedging strategy with fixed initial condition. Next we consider an optimal initial condition. Finally, we study a binomial model as a simple example.

Original languageEnglish
Pages (from-to)219-252
Number of pages34
JournalApplied Mathematical Finance
Volume16
Issue number3
DOIs
Publication statusPublished - Nov 23 2009

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All Science Journal Classification (ASJC) codes

  • Applied Mathematics
  • Finance

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