This paper analyzes the application of quantile hedging on equity-linked life insurance contracts in the presence of transaction costs. Following the time-based replication strategy, we present the explicit expressions for the present values of expected hedging errors and transaction costs. The results are derived by using the adjusted hedging volatility σ̄ proposed by Leland. Furthermore, the e...

The goal of these lectures is to present a survey of recent developments in the practically important and challenging area of hedging credit risk. In a companion work, Bielecki et al. (2004a), we presented techniques and results related to the valuation of defaultable claims. It should be emphasized that in most existing papers on credit risk, the risk-neutral valuation of defaultable claims is...

Uncertainty is a problem not only in human decision-making, but is a prevalent quality of natural environments and thus requires evolutionary response. Unpredictable natural selection is expected to result in the evolution of bet-hedging strategies, which are adaptations to long-term fluctuating selection. Despite a recent surge of interest in bet hedging, its study remains mired in conceptual ...

We address the problem of valuation and hedging of Asian basket and spread options derivatives common in energy markets. We extend the Generalized LogNormal approach, introduced in Borovkova et al. (2007), to Asian basket options and apply it to energy option markets. We provide closed form formulae for the option price and the greeks, which is extremely useful for option traders. Inverting the...

Most existing annotation schemes for hedging were created to aid in the automatic identification of hedges in formal language styles, such as used in scholarly prose. Language with informal tone, typical in much web content, poses a challenge and provides illuminating case studies for the analysis of the use of hedges. We have analysed conversations from a web forum and identified the manners i...

This paper presents a new approach to the pricing and hedging problem for contingent claims in incomplete markets. We assume that traders wish to maximize the expected final payoff of the hedging portfolio and the claims, and we avoid the use of utility functions. Instead, we model how traders are punished when taking excessive risks in practice. To do so, we introduce an extra reserve bank acc...

We study a manufacturing firm that builds a product to stock to meet a random demand. Production time is deterministic, so that if there is a backlog, customers are quoted a firm lead time that is proportional to the backlog. In order to represent the customers’ response to waiting, we introduce a new defection function — the probability that a customer chooses not to order as a function of the...

We analyze optimal risk management strategies of a bank financed with deposits and equity in a one period model. The bank’s motivation for risk management comes from deposits which can lead to bank runs. In the event of such a run, liquidation costs arise. The hedging strategy that maximizes the value of equity is derived. We identify conditions under which well known results such as complete h...

Theoretical research predicted that firms with convex tax schedules would hedge to minimize expected taxes. However, previous empirical research did not detect a relationship between derivative use and tax losses carry forward, which contribute to tax schedule convexity. This study aims to show that the tax incentive to hedge depends on tax losses carry forward and the ability of the firm to ca...

We compare the performance of various hedging strategies for index collateralized debt obligation (CDO) tranches across a variety of models and hedging methods during the recent credit crisis. Our empirical analysis shows evidence for market incompleteness: a large proportion of risk in the CDO tranches appears to be unhedgeable. We also show that, unlike what is commonly assumed, dynamic model...