Variance-optimal hedging for processes with stationary independent increments

Details Variance-optimal hedging for processes with stationary independent increments Variance-optimal hedging for processes with stationary independent increments

2006-07-05

arxiv.org/abs/math/0607112v1

Annals of Applied Probability 2006, Vol. 16, No. 2, 853-885

Mathematics

Probability

Published at http://dx.doi.org/10.1214/105051606000000178 in the Annals of Applied Probability (http://www.imstat.org/aap/) by

Scientific paper

10.1214/105051606000000178

We determine the variance-optimal hedge when the logarithm of the underlying price follows a process with stationary independent increments in discrete or continuous time. Although the general solution to this problem is known as backward recursion or backward stochastic differential equation, we show that for this class of processes the optimal endowment and strategy can be expressed more explicitly. The corresponding formulas involve the moment, respectively, cumulant generating function of the underlying process and a Laplace- or Fourier-type representation of the contingent claim. An example illustrates that our formulas are fast and easy to evaluate numerically.

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