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There is no Nontrivial Hedging Portfolio for Option Pricing with Transaction Costs

Soner, H. M. and Shreve, S. E. and Cvitanić, J. (1995) There is no Nontrivial Hedging Portfolio for Option Pricing with Transaction Costs. Annals of Applied Probability, 5 (2). pp. 327-355. ISSN 1050-5164. http://resolver.caltech.edu/CaltechAUTHORS:SONaap95

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Abstract

Conventional wisdom holds that since continuous-time, Black-Scholes hedging is infinitely expensive in a model with proportional transaction costs, there is no continuous-time strategy which hedges a European call option perfectly. Of course, if one is attempting to dominate the European call rather than replicate it, then one can use the trivial strategy of buying one share of the underlying stock and holding to maturity. In this paper we prove that this is, in fact, the least expensive method of dominating a European call in a Black-Scholes model with proportional transaction costs.


Item Type:Article
Related URLs:
URLURL TypeDescription
http://dx.doi.org/10.1214/aoap/1177004767DOIUNSPECIFIED
http://projecteuclid.org/euclid.aoap/1177004767PublisherUNSPECIFIED
http://links.jstor.org/sici?sici=1050-5164%28199505%295%3A2%3C327%3ATINNHP%3E2%2E0%2ECO%3B2-I&origin=euclidPublisherUNSPECIFIED
Additional Information:1995 © Institute of Mathematical Statistics. Received May 1994; revised October 1994. [H.M.S.] Work supported by NSF Grant DMS-92-008021. [S.E.S.] Work supported by NSF Grant DMS-92-03360. [J.C.] Work supported by NSF Grant DMS-93-19816.
Funders:
Funding AgencyGrant Number
National Science FoundationDMS-92-008021
National Science FoundationDMS-92-03360
National Science FoundationDMS-93-19816
Subject Keywords:transaction costs; hedging; option pricing; Black-Scholes portfolio
Record Number:CaltechAUTHORS:SONaap95
Persistent URL:http://resolver.caltech.edu/CaltechAUTHORS:SONaap95
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:11676
Collection:CaltechAUTHORS
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Deposited On:18 Sep 2008 20:31
Last Modified:26 Dec 2012 10:17

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