The Mathematical Institute, University of Oxford, Eprints Archive

Utility-Based Hedging of Stochastic Income

Tan, Vincent (2013) Utility-Based Hedging of Stochastic Income. Masters thesis, Oxford University.

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Abstract

In this dissertation, we study and examine utility-based hedging of the optimal portfolio choice problem in stochastic income. By assuming that the investor has a preference governed by negative exponential utility, we a derive a closed-form solution for the indifference price through the pricing methodology based on utility maximization criteria. We perform asymptotic analysis on this closed form solution to develop the analytic approximation for the indifference price and the optimal hedging strategy as a power series expansion involving the risk aversion and the correlation between the income and a traded asset. This gives a fast computation route to assess these quantities and perform our analysis. We implemented the model to perform simulations for the optimal hedging policy and produce the distributions of the hedging error at terminal time over many sample paths histories. In turn, we analyze the performance of the utility-based hedging strategy together with the strategy which arises from employing the traded asset as a substitute for the stochastic income.

Item Type:Thesis (Masters)
Subjects:H - N > Mathematics education
Research Groups:Mathematical and Computational Finance Group
ID Code:1743
Deposited By: Laura Auger
Deposited On:13 Aug 2013 19:11
Last Modified:29 May 2015 19:26

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