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Dynamic hedging in incomplete markets: a simple solution

Basak, Suleyman and Chabakauri, Georgy (2012) Dynamic hedging in incomplete markets: a simple solution. Review of Financial Studies, 25 (6). pp. 1845-1896. ISSN 0893-9454

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Identification Number: 10.1093/rfs/hhs050


We provide fully analytical, optimal dynamic hedges in incomplete markets by employing the traditional minimum-variance criterion. Our hedges are in terms of generalized “Greeks” and naturally extend no-arbitrage–based risk management in complete markets to incomplete markets. Whereas the literature characterizes either minimum-variance static, myopic, or dynamic hedges from which a hedger may deviate unless able to precommit, our hedges are time-consistent. We apply our results to derivatives replication with infrequent trading and determine hedges and replication values, which reduce to generalized Black-Scholes expressions in specific settings. We also investigate dynamic hedging with jumps, stochastic correlation, and portfolio management with benchmarking.

Item Type: Article
Official URL:
Additional Information: © 2012 The Author
Divisions: Finance
Subjects: H Social Sciences > HG Finance
JEL classification: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods and Programming > C61 - Optimization Techniques; Programming Models; Dynamic Analysis
D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty
G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
Date Deposited: 12 Jun 2012 11:05
Last Modified: 20 Oct 2021 01:57

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