![Sample our Engineering & Technology journals, sign in here to start your access, latest two full volumes FREE to you for 14 days]({"type":"image" , "src" : "/sda/5933/TOC-Subject-Sample-2021-Engineering-Tech.jpg"})
Abstract
In this article, we develop a semi-definite programming-based receding horizon control approach to the problem of dynamic hedging of European basket call options under proportional transaction costs. The hedging problem for a European call option is formulated as a finite horizon constrained stochastic control problem. This allows us to develop a receding horizon control approach that repeatedly solves semi-definite programmes on-line in order to dynamically hedge. This approach is competitive with Black–Scholes delta hedging in the one-dimensional case with no transaction costs, but it also applies to multi-dimensional options such as basket options, and can include transaction costs. We illustrate its effectiveness through a numerical example involving an option on a basket of five stocks.
Acknowledgements
The author would like to thank Chang Hwan Sung for the estimated mean and covariance stock parameters, and Wilfred Wong and Supakorn Mudchanatongsuk for their MoM basket option pricing code. The author is also indebted to Alberto Bemporad for his meticulous reading of an earlier version of this article and his detailed feedback and suggestions that improved this article. Finally, the valuable feedback from the anonymous second reviewer was greatly appreciated.
