Option Pricing and Hedging with Small Transaction Costs
Pricing of Securities
2012-12-13 v2 Optimization and Control
Probability
Portfolio Management
Abstract
An investor with constant absolute risk aversion trades a risky asset with general It\^o-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.
Keywords
Cite
@article{arxiv.1209.2555,
title = {Option Pricing and Hedging with Small Transaction Costs},
author = {Jan Kallsen and Johannes Muhle-Karbe},
journal= {arXiv preprint arXiv:1209.2555},
year = {2012}
}
Comments
20 pages, to appear in "Mathematical Finance"