Proceedings of the
The Nineteenth International Conference on Computational Intelligence and Security (CIS 2023)
December 1 – 4, 2023, Haikou, China
Research on Explicit Solution of Dynamic European Option Hedging Model
School Of Business Administration, South China University of Technology, China.
ABSTRACT
This paper constructs a dynamic options hedging model with the objective of maximizing the utility of the total return at the end of the period, considering option premium as the hedging cost. After proving the existence and uniqueness of the solution in our model, the explicit solution of the optimal position is obtained based on the quadratic utility function. Parameters prediction method is introduced through the sliding prediction of GARCH model. We study the empirical analysis of the hedging model and do an out-of-sample test to verify the hedging effect of the proposed model. We select two intervals for the downtrend and uptrend prices of the underlying asset, and compare the proposed dynamic model with the static one. The results show that in the case of a decrease in the price of the underlying asset, dynamic adjustment reduces uncertainty and stabilizes the total return with the large strike prices. In the case of an increase in the price of the underlying asset, there is little difference between dynamic and static hedging.
Keywords: Option hedging, Dynamic model, Maximum utility, Explicit solution.
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School Of Business Administration, South China University of Technology, China.
ABSTRACT
This paper constructs a dynamic options hedging model with the objective of maximizing the utility of the total return at the end of the period, considering option premium as the hedging cost. After proving the existence and uniqueness of the solution in our model, the explicit solution of the optimal position is obtained based on the quadratic utility function. Parameters prediction method is introduced through the sliding prediction of GARCH model. We study the empirical analysis of the hedging model and do an out-of-sample test to verify the hedging effect of the proposed model. We select two intervals for the downtrend and uptrend prices of the underlying asset, and compare the proposed dynamic model with the static one. The results show that in the case of a decrease in the price of the underlying asset, dynamic adjustment reduces uncertainty and stabilizes the total return with the large strike prices. In the case of an increase in the price of the underlying asset, there is little difference between dynamic and static hedging.
Keywords: Option hedging, Dynamic model, Maximum utility, Explicit solution.
Download PDF