A Receding Horizon Control Formulation of European Basket Option Hedging

J.A. Primbs, S. Mudchanatongsuk, and W. Wong (USA)


Financial Derivatives, Dynamic Hedging, Receding Hori zon Control, Basket Options.


In this paper we develop a semi-definite programming based receding horizon control approach to the problem of dynamic hedging of European basket call options. The hedging problem for a European call option is formulated as a finite horizon constrained stochastic control problem. This allows us to develop a receding horizon control ap proach that repeatedly solves semi-definite programs on line in order to dynamically hedge. This approach is com petitive with Black-Scholes in the one-dimensional case, but also scales well with problem size, applies to basket options, and can potentially include other forms of con straints. We illustrate its effectiveness through numerical examples.

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