Hedging NonTradable Risks with Transaction Costs and Price Impact
Abstract
An agent hedges exposure to a nontradable risk factor U using a correlated traded asset S and accounts for the impact of trades on both factors. We obtain in closedform the optimal strategy when the agent holds a linear... [ view full abstract ]
An agent hedges exposure to a nontradable risk factor U using a correlated traded asset S and accounts for the impact of trades on both factors. We obtain in closedform the optimal strategy when the agent holds a linear position in U. With nonlinear exposure to U, we provide an approximation to the optimal strategy in closedform, and prove that the value function is correctly approximated when crossimpact and riskaversion are small. With nonlinear exposure, the approximate optimal strategy can be written in terms of the optimal strategy for linear exposure with the size of the position changing dynamically according to the exposure's "Delta" under a particular probability measure.
Authors

Ryan Donnelly
(University of Washington)

Sebastian Jaimungal
(University of Toronto)

Alvaro Cartea
(University of Oxford)
Topic Areas
Hedging , Optimal Execution , Price Impact
Session
WEAEM » Optimal Execution, and LOB Models (11:30  Wednesday, 18th July, Emmet)
Presentation Files
The presenter has not uploaded any presentation files.