Chapter-14-Total-Risk-Minimization-Using-Monte-Carlo-Simulations_2007_Handbooks-in-Operations-Research-and-Management-Science推荐.pdfVIP

J.R. Birge and V. Linetsky (Eds.), Handbooks in OR MS, Vol. 15 Copyright © 2008 Elsevier B.V. All rights reserved DOI: 10.1016/S0927-0507(07)15014-3 Chapter 14 Total Risk Minimization Using Monte Carlo Simulations Thomas F. Coleman Department of Combinatorics and Optimization, University of Waterloo, Waterloo, ON, N2L 3G1, Canada E-mail: tfcoleman@uwaterloo.ca Yuying Li School of Computer Science, University of Waterloo, Waterloo, ON, N2L 3G1, Canada E-mail: yuying@uwaterloo.ca Maria-Cristina Patron Risk Capital, 1790 Broadway, 15th Floor, New York, NY 10019, USA Abstract In an incomplete market, it is generally impossible to replicate an option exactly. In this case, total risk minimization chooses an optimal self-financing strategy that best approximates the option payoff by its final value. Total risk minimization is a dynamic stochastic programming problem, which is generally very challenging to solve; a direct approach may lead to very expensive computations. We investigate total risk minimization using a piecewise linear criterion. We de- scribe a method for computing the optimal hedging strategies for this stochastic programming problem using Monte Carlo simulation and spline approximations. We illustrate this method in the Black–Scholes and the stochastic volatility frameworks. We also compare the hedging performance of the strategies based on piecewise lin- ear risk minimization, the traditional, quadratic risk minimizing strategies and the shortfall risk minimizing strategies. The numerical results show that piecewise linear risk minimization may lead to smaller hedging cost and significantly different, possi- bly better, hedging strategies. The values of the shortfall risk for the piecewise linear total risk minimizing strategies suggest that these strategies typicall