Download This PaperOptimal Hedging When the Underlying Asset Follows a Regime-Switching Markov Process
34 Pages Posted: 17 Aug 2012 Last revised: 19 Aug 2012
Date Written: August 16, 2012
Abstract
We develop a flexible discrete-time hedging methodology that miminizes the expected value of any desired penalty function of the hedging error within a general regime-switching framework. A numerical algorithm based on backward recursion allows for the sequential construction of an optimal hedging strategy. Numerical experiments comparing this and other methodologies show a relative expected penalty reduction ranging between 0.9% and 12.6% with respect to the best benchmark.
Keywords: Dynamic programming, hedging, risk management, regime switching
JEL Classification: G32, C61
Suggested Citation: Suggested Citation
Francois, Pascal and Gauthier, Genevieve and Godin, Frédéric, Optimal Hedging When the Underlying Asset Follows a Regime-Switching Markov Process (August 16, 2012). 25th Australasian Finance and Banking Conference 2012, Available at SSRN: https://ssrn.com/abstract=2130822 or http://dx.doi.org/10.2139/ssrn.2130822
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