Dynamic hedging of single and multi-dimensional options with transaction costs: a generalized utility maximization approach

Abstract

We propose a new methodology for discrete time dynamic hedging with transaction costs that has three key performance features. First, the methodology can accommodate the use of a wide range of objective functions, from the use of many types of utility functions to the more traditional objectives of hedging error minimization. Second, our methodology can significantly outperform traditional dynamic hedging methodologies across a range of objective functions. Third, our methodology can be applied to both single and multi-dimensional options while analytical methods typically can only be applied to single dimensional options.

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