The Best Hedging Strategy in the Presence of Transaction Costs

International Journal of Theoretical and Applied Finance, Vol. 12, No. 6, pp. 833-860, 2009

Posted: 1 Dec 2009

See all articles by Valeriy Zakamulin

Valeriy Zakamulin

University of Agder - School of Business and Law

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Abstract

Considerable theoretical work has been devoted to the problem of option pricing and hedging with transaction costs. A variety of methods have been suggested and are currently being used for dynamic hedging of options in the presence of transaction costs. However, very little was done on the subject of an empirical comparison of different methods for option hedging with transaction costs. In a few existing studies the different methods are compared by studying their empirical performances in hedging only a plain-vanilla short call option. The reader is tempted to assume that the ranking of the different methods for hedging any kind of option remains the same as that for a vanilla call. The main goal of this paper is to show that the ranking of the alternative hedging strategies depends crucially on the type of the option position being hedged and the risk preferences of the hedger. In addition, we present and implement a simple optimization method that, in some cases, improves considerably the performance of some hedging strategies.

Keywords: Option hedging, transaction costs, simulations, risk-return tradeoff, optimization

Suggested Citation

Zakamulin, Valeriy, The Best Hedging Strategy in the Presence of Transaction Costs. International Journal of Theoretical and Applied Finance, Vol. 12, No. 6, pp. 833-860, 2009. Available at SSRN: https://ssrn.com/abstract=1515568

Valeriy Zakamulin (Contact Author)

University of Agder - School of Business and Law ( email )

Service Box 422
Kristiansand, N-4604
Norway
+47 38141039 (Phone)

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