Mastering R for Quantitative Finance

Summary

In this chapter, we have shown some practical problems that arise in the hedging of derivatives. Although the Black-Scholes-Merton model assumes continuous time trading, resulting in continuous rebalancing of the hedging portfolio without transaction costs, in reality, trading occurs in discrete time, and it does have costs. Consequently, the cost of hedging depends on the future path of the spot price of the underlying asset; thus, it is not a single value presented by the analytical formula any more, but it is a stochastic variable that can be described by its probability distribution. In this chapter, we simulated different paths, calculated the cost of hedging, and presented the probability distribution assuming different rebalancing ...