Local risk minimization for vulnerable European contingent claims on nontradable assets under regime switching models. Issue 4 (3rd July 2016)

• Record Type: Journal Article
• Authors: Wang, Wei; Jin, Zhuo; Qian, Linyi; Su, Xiaonan
• Is Part Of: Stochastic analysis and applications. Volume 34:Issue 4(2016)
• Page Start: 662
• Page End: 678
• Publication Date: 2016-07-03
• Subjects: Default risk -- local risk minimization -- regime switching -- non-tradable assets; C13 -- G13; Stochastic analysis -- Periodicals; 519.2205
• DOI: 10.1080/07362994.2016.1166061
• Languages: English
• ISSNs: 0736-2994

Abstract

ABSTRACT: This article focuses on an optimal hedging problem of the vulnerable European contingent claims. The underlying asset of the vulnerable European contingent claims is assumed to be nontradable. The interest rate, the appreciation rate and the volatility of risky assets are modulated by a finite-state continuous-time Markov chain. By using the local risk minimization method, we obtain an explicit closed-form solution for the optimal hedging strategies of the vulnerable European contingent claims. Further, we consider a problem of hedging for a vulnerable European call option. Optimal hedging strategies are obtained. Finally, a numerical example for the optimal hedging strategies of the vulnerable European call option in a two-regime case is provided to illustrate the sensitivities of the hedging strategies.