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Title: Performance of utility-based strategies for hedging basis risk
Authors: Monoyios, M
Issue Date: 2003
Publisher: Brunel University
Citation: Economics and Finance Working papers, Brunel University, 03-13
Abstract: The performance of optimal strategies for hedging a claim on a non- traded asset is analyzed. The claim is valued and hedged in a utility max- imization framework, using exponential utility. A traded asset, correlated with that underlying the claim, is used for hedging, with the correlation typically close to 1. Using a distortion method [30, 31] we derive a non- linear expectation representation for the claim's ask price and a formula for the optimal hedging strategy. We generate a perturbation expansion for the price and hedging strategy in powers of 2 = 1􀀀 2. The terms in the price expansion are found to be proportional to the central moments of the claim payo under a measure equivalent to the physical measure. The resulting fast computation capability is used to carry out a simulation based test of the optimal hedging program, computing the terminal hedg- ing error over many asset price paths. These errors are compared with those from a naive strategy which us...
Appears in Collections:Dept of Economics and Finance Research Papers

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