Data Management

Dynamic Hedging In Incomplete Markets: A Simple Solution

Free registration required

Executive Summary

Despite much work on hedging in incomplete markets, the literature still lacks tractable dynamic hedges in plausible environments. In this paper, the authors provide a simple solution to this problem in a general incomplete-market economy in which a hedger, guided by the traditional minimum-variance criterion, aims at reducing the risk of a non-tradable asset. They derive fully analytical optimal hedges and demonstrate that they can easily be computed in various stochastic environments. Their dynamic hedges preserve the simple structure of complete-market perfect hedges and are in terms of generalized "Greeks," familiar in risk management applications, as well as retaining the intuitive features of their static counterparts.

  • Format: PDF
  • Size: 296.1 KB