Pre-Hedging

45 Pages Posted: 5 Jul 2023 Last revised: 11 Jul 2024

See all articles by Johannes Muhle-Karbe

Johannes Muhle-Karbe

Imperial College London - Department of Mathematics

Roel C. A. Oomen

Deutsche Bank AG (London); Imperial College London - Department of Mathematics; London School of Economics & Political Science (LSE) - Department of Statistics

Date Written: April 10, 2024

Abstract

This paper studies a dealer that pre-hedges anticipated potential trades and we analyse how this affects the client's overall execution outcome. Pre-hedging can benefit both parties: improved risk management over an extended horizon enables the dealer to charge reduced spreads that more than offset any adverse impact the pre-hedging activity has on the execution price. However, when a dealer pre-hedges too aggressively, this can be detrimental to the client. Timing uncertainty of the potential trade is an effective control held by the client to mitigate any counter-productive pre-hedging. Our results are robust to a setting where competing dealers simultaneously pre-hedge.

Suggested Citation

Muhle-Karbe, Johannes and Oomen, Roel C.A., Pre-Hedging (April 10, 2024). Available at SSRN: https://ssrn.com/abstract=4499729 or http://dx.doi.org/10.2139/ssrn.4499729

Johannes Muhle-Karbe

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
Imperial College
LONDON, SW7 1NE
United Kingdom

HOME PAGE: http://www.ma.imperial.ac.uk/~jmuhleka/

Roel C.A. Oomen (Contact Author)

Deutsche Bank AG (London) ( email )

Winchester House
1 Great Winchester Street
London, EC2N 2DB
United Kingdom

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
Imperial College
LONDON, SW7 2AZ
United Kingdom

London School of Economics & Political Science (LSE) - Department of Statistics ( email )

Houghton Street
London, England WC2A 2AE
United Kingdom

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