Robust One-Period Option Hedging

Authors:
Frank Lutgens;Jos Sturm;Antoon Kolen
Affiliations:
Department of Finance, Maastricht University, Tongerseweg 53, 6200 MD, Maastricht, The Netherlands;Department of Econometrics, Tilburg University, Tilburg, The Netherlands;Department of Quantitative Economics, Maastricht University, Maastricht, The Netherlands
Venue:
Operations Research
Year:
2006

Citing 6
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Abstract

We consider robust optimization to cope with uncertainty about the stock return process in one-period option hedging problems. The robust approach relates portfolio choice to uncertainty, making more cautious hedges when uncertainty is high. We represent uncertainty by a set of plausible expected returns of the underlying stocks and show that for this set the robust problem is a second-order cone program that can be solved efficiently. We apply the approach to find an optimal portfolio to hedge an index option.