Raj Sau (UCSB)

Title: HEDGING IN MODELS WITH JUMPS AND TRANSACTION COSTS - a survey

Abstract: Transaction costs invalidate Black-Scholes argument, since continuous revision implies infinite trading. Hence it is necessary to rebalance in discrete time steps, which results in hedging error. The hedging strategies can be classified into two main categories, time-based and move-based (utility) strategies. The goal is to minimize the variance of hedging error. If the asset price follows a jump diffusion, the market is in general incomplete. Kennedy, Forsyth Vetzal devise a strategy that simultaneously eliminates diffusion risk, and minimizes an objective that is a linear combination of jump risk and transaction cost. In this survey I review the above hedging methods.