Hedging Options Under Transaction Costs and Stochastic Volatility

Posted: 23 May 2003

See all articles by Roy Kouwenberg

Roy Kouwenberg

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Mahidol University - College of Management

Jacek Gondzio

University of Edinburgh - School of Mathematics

Ton Vorst

VU University Amsterdam - Department of Finance and Financial Sector Management; Tinbergen Institute

Abstract

In this paper we consider the problem of hedging contingent claims on a stock under transaction costs and stochastic volatility. Extensive research has clearly demonstrated that the volatility of most stocks is not constant over time. As small changes of the volatility can have a major impact on the value of contingent claims, hedging strategies should try to eliminate this volatility risk. We propose a stochastic optimization model for hedging contingent claims that takes into account the effects of stochastic volatility, transaction costs and trading restrictions. Simulation results show that our approach could improve performance considerably compared to traditional hedging strategies.

Keywords: Option hedging, Stochastic Volatility, Stochastic Programming, Computational Finance

JEL Classification: G10, G11, G13

Suggested Citation

Kouwenberg, Roy R. P. and Gondzio, Jacek and Vorst, Ton A.C.F., Hedging Options Under Transaction Costs and Stochastic Volatility. Available at SSRN: https://ssrn.com/abstract=379620

Roy R. P. Kouwenberg (Contact Author)

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Mahidol University - College of Management ( email )

69 Vipawadee Rangsit Road
Bangkok, 10400
Thailand

HOME PAGE: http://https://www.cm.mahidol.ac.th/web/index.php/18-faculty/148-roy-kouwenberg-ph-d-cfa

Jacek Gondzio

University of Edinburgh - School of Mathematics ( email )

United Kingdom

Ton A.C.F. Vorst

VU University Amsterdam - Department of Finance and Financial Sector Management ( email )

De Boelelaan 1105
NL-1081HV Amsterdam
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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