Norwegian School of Economics and Business Administration Discussion Paper No. 19 2002
27 Pages Posted: 4 Feb 2010
Date Written: November 21, 2003
In this paper we provide a systematic treatment of the utility based option pricing and hedging approach in markets with both fixed and proportional transaction costs: We extend the framework developed by Davis, Panas and Zariphopoulou (1993) and formulate the option pricing and hedging problem. We propose and implement a numerical procedure for computing option prices and corresponding optimal hedging strategies. We present a careful analysis of the optimal hedging strategy and elaborate on important differences between the exact hedging strategy and the asymptotic hedging strategy of Whaley and Wilmott (1994). We provide a simulation analysis in order to compare the performance of the utility based hedging strategy against the asymptotic strategy and some other common strategies.
Keywords: Option pricing, option hedging, transaction costs, stochastic impulse control, Markov chain approximation
JEL Classification: C61, G11, G13
Suggested Citation: Suggested Citation
Zakamulin, Valeriy, European Option Pricing and Hedging with Both Fixed and Proportional Transaction Costs (November 21, 2003). Norwegian School of Economics and Business Administration Discussion Paper No. 19 2002. Available at SSRN: https://ssrn.com/abstract=471701 or http://dx.doi.org/10.2139/ssrn.471701