A stochastic model predictive control approach to dynamic option hedging with transaction costs

@article{Bemporad2011ASM,
  title={A stochastic model predictive control approach to dynamic option hedging with transaction costs},
  author={Alberto Bemporad and Laura Puglia and Tommaso Gabbriellini},
  journal={Proceedings of the 2011 American Control Conference},
  year={2011},
  pages={3862-3867}
}
This paper proposes a stochastic model predictive control (SMPC) approach to hedging derivative contracts (such as plain vanilla and exotic options) in the presence of transaction costs. The methodology is based on the minimization of a stochastic measures of the hedging error predicted for the next trading date. Three different measures are proposed to determine the optimal composition of the replicating portfolio. The first measure is a combination of variance and expected value of the… CONTINUE READING

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