Wednesday, January 07, 2009

Thoughts on Hedging Illiquid Assets (Hedging Under Liquidity Constraints)

An option price is the cost of hedging the contingent claim during its life. But when liquidity is scares, and buying stocks would influence the price, there would be cost in terms of the cost of slippage and miss hedges which would influence the price.
The cost of creating the replicating portfolio would be the price of the option. If the hedging is done using a particular strategy then the options should be the cost of hedging the option position using the particular strategy.
Suminda Sirinath Salpitikorala Dharmasena

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