A Martingale Characterization of Consumption Choices and Hedging Costs with Margin Requirements

Posted: 12 Oct 2000

See all articles by Hong Liu

Hong Liu

Washington University in St. Louis - Olin Business School; Fudan University - China Institute of Economics and Finance

Domenico Cuoco

University of Pennsylvania - Finance Department

Abstract

This paper examines optimal consumption and investment choices and the cost of hedging contingent claims in the presence of margin requirements or, more generally, of nonlinear wealth dynamics and constraints on the portfolio policies. Existence of optimal policies is established using martingale and duality techniques under general assumptions on the securities? price process and the investor?s preferences. As an illustration, explicit solutions are provided for an agent with logarithmic utility. A PDE characterization of the cost of hedging a nonnegative path-independent European contingent claim is also provided.

Suggested Citation

Liu, Hong and Cuoco, Domenico, A Martingale Characterization of Consumption Choices and Hedging Costs with Margin Requirements. Mathematical Finance, Vol. 10, No. 3, July 2000. Available at SSRN: https://ssrn.com/abstract=242878 or http://dx.doi.org/10.2139/ssrn.242878

Hong Liu

Washington University in St. Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-5883 (Phone)

Fudan University - China Institute of Economics and Finance ( email )

China

Domenico Cuoco (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

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