The Frontiers of Society, Science and Technology, 2020, 2(11); doi: 10.25236/FSST.2020.021102.
Hantao Zhou1, Jiong Huang2, Qianwei Yin3
1 School of Politics and Economics, King’s College London, London WC2R 2LS, United Kingdom
2 School of Business, Macau University of Science and Technology, Macau, China
3 School of Surveying and Mapping, Wuhan University, Wuhan 430072, China
The research problem is how large the replication error is if an investor Delta hedges an European option over many short periods. In the project, the trinomial stock price tree is firstly built to simulate stock price changes. Then, Monte-Carlo approximation is used to put many short-period trinomial tree models together and derive the average hedging errors. The hedging errors become significantly smaller as periods involved in the trinomial tree models pass a certain number. This method can be used to create portfolios with European options.
Option pricing, Trinomial tree model, Delta hedging, Replication error
Hantao Zhou, Jiong Huang, Qianwei Yin. Reduction of the Hedging Error in the Trinomial Tree Model. The Frontiers of Society, Science and Technology (2020) Vol. 2 Issue 11: 8-13. https://doi.org/10.25236/FSST.2020.021102.
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