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Option Pricing and Hedging with Small Transaction Costs (1209.2555v2)
Published 12 Sep 2012 in q-fin.PR, math.OC, math.PR, and q-fin.PM
Abstract: An investor with constant absolute risk aversion trades a risky asset with general It^o-dynamics, in the presence of small proportional transaction costs. In this setting, we formally derive a leading-order optimal trading policy and the associated welfare, expressed in terms of the local dynamics of the frictionless optimizer. By applying these results in the presence of a random endowment, we obtain asymptotic formulas for utility indifference prices and hedging strategies in the presence of small transaction costs.