The Mathematical Institute, University of Oxford, Eprints Archive

Marginal utility-based hedging of claims on non-traded assets with partial information

Monoyios, Michael (2008) Marginal utility-based hedging of claims on non-traded assets with partial information. preprint . (Submitted)

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Abstract

We examine optimal hedging of a claim on a non-traded asset, using a
correlated traded asset, when one does not know with certainty the
values of the asset price drifts. In this partial information setting,
the uncertain parameters are considered as random variables. We filter
the drifts from price observations, updating a chosen prior
distribution. The result is an effective full information model with
random drift parameters. Using a dual approach, we derive
representations for the indifference price and optimal hedging
strategy, with exponential utility. Using the marginal utility-based
price as an approximation to the indifference price, analytic formulae
for the optimal hedge are possible, and this allows a simulation study
of the optimal hedging program to be carried out. The results indicate
improved hedging performance relative to a Black-Scholes strategy
which takes the correlation as perfect, and also relative to a
utility-based hedging program which does not incorporate learning.

Item Type:Article
Subjects:D - G > Game theory, mathematical finance, economics, social and behavioral sciences
O - Z > Probability theory and stochastic processes
Research Groups:Mathematical and Computational Finance Group
ID Code:723
Deposited By:Michael Monoyios
Deposited On:01 Aug 2008
Last Modified:20 Jul 2009 14:23

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