G-2012-44
Optimal Hedging when the Underlying Asset Follows a Regime-Switching Markov Process
Pascal François, Geneviève Gauthier, and Frédéric Godin
We develop a flexible discrete-time hedging methodology that miminizes the expected value of any desired penalty function of the hedging error within a general regime-switching framework. A numerical algorithm based on backward recursion allows for the sequential construction of an optimal hedging strategy. Numerical experiments comparing this and other methodologies show a relative expected penalty reduction ranging between 0.9% and 12.6% with respect to the best benchmark.
Published August 2012 , 27 pages