Feedback effects of dynamic hedging strategies in the presence of transaction costs

Agliardi, Elettra ; Andergassen, Rainer (2002) Feedback effects of dynamic hedging strategies in the presence of transaction costs. DOI 10.6092/unibo/amsacta/644.
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Abstract

We study the destabilising effect of dynamic hedging strategies on the price of the underlying in the presence of sunk costs of transaction. Once sunk costs of transaction are taken into account, continuous portfolio rehedging is no longer an optimal strategy. Using a non-optimising (local in time) strategy for portfolio rebalancing, explicit dynamics for the price of the underlying are derived, focusing in particular on the excess volatility and feedback effects of these portfolio insurance strategies. Further, we show how these latter depend on the heterogeneity of the insured payoffs. Finally, conditions are derived under which it may still be reasonable, from a practical viewpoint, to implement Black - Scholes strategies.

Abstract
Document type
Monograph (Working Paper)
Creators
CreatorsAffiliationORCID
Agliardi, Elettra
Andergassen, Rainer
Keywords
dynamic hedging volatility Black-Scholes model transaction costs
Subjects
DOI
Deposit date
17 Jun 2004
Last modified
17 Feb 2016 13:59
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