Optimal Portfolio Hedging with Nonlinear Derivatives and Transaction Costs |
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Authors: | Jussi Keppo Samu Peura |
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Affiliation: | (1) Systems Analysis Laboratory, Helsinki University of Technology, Otakaari 1, 02150 Espoo, Finland;(2) Risk Management, Postipankki Ltd., Unioninkatu 22, FIN-00007 Helsinki, Finland |
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Abstract: | We consider the problem of dynamically hedging a fixed portfolio of assets in the presence of non-linear instruments and transaction costs, as well as constraints on feasible hedging positions. We assume an investor maximizing the expected utility of his terminal wealth over a finite holding period, and analyse the dynamic portfolio optimization problem when the trading interval is fixed. An approximate solution is obtained from a two-stage numerical procedure. The problem is first transformed into a nonlinear programming problem which utilizes simulated coefficient matrices. The nonlinear programming problem is then solved numerically using standard constrained optimization techniques. |
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Keywords: | optimal portfolio hedging nonlinear programming Monte Carlo simulation |
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