Option Pricing and Hedging with Small Transaction Costs

2012/09/12 by Kallsen, Jan, Muhle-Karbe, Johannes · 1 citation
#FOS: Economics and business #FOS: Mathematics #Optimization and Control (math.OC) #Portfolio Management (q-fin.PM) #Pricing of Securities (q-fin.PR) #Probability (math.PR)

paper · doi:10.48550/arxiv.1209.2555

Abstract

An investor with constant absolute risk aversion trades a risky asset with general Itô-dynamics, in the presence of small proportional transaction costs. In this setting, we formally derive a leading-order optimal trading policy and the associated welfare, expressed in terms of the local dynamics of the frictionless optimizer. By applying these results in the presence of a random endowment, we obtain asymptotic formulas for utility indifference prices and hedging strategies in the presence of small transaction costs.

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