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Risk-minimizing hedging for stochastic payment styled contingent claims

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2 Author(s)
Jian-hua Guo ; Bus. Sch., Univ. of Shanghai for Sci. & Technol., Shanghai, China ; Qing-xian Xiao

Measuring financial risks with the conditional mean square error process of cost, we construct risk-minimizing hedging model and study the dynamic hedging problem for stochastic payment styled contingent claims. For any given contingent claim with stochastic payment flow, we firstly prove that there is a unique risk-minimizing hedging strategy by taking advantage of the G-K-W decomposition theorem; then, with the Bellman's principle of optimality, explicit expressions of hedging strategies are acquired and these expressions only comprise conditional moments of risky asset's price and stochastic payment; lastly, at the end of this paper, we take insurance payment for an example to illustrate the technique and conclusions mentioned in this paper are reasonable and feasible.

Published in:

Industrial Engineering and Engineering Management (IE&EM), 2010 IEEE 17Th International Conference on

Date of Conference:

29-31 Oct. 2010