2010•Cambridge University Press eBooksOpen access

A Guided Tour through Quadratic Hedging Approaches

MARTIN P. SCHWEIZER

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Abstract

This paper gives an overview of results and developments in the area of pricing and hedging contingent claims in an incomplete market by means of a quadratic criterion. We first present the approach of risk-minimization in the case where the underlying discounted price process X is a local martingale. We then discuss the extension to local risk-minimization when X is a semimartingale and explain the relations to the Föllmer-Schweizer decomposition and the minimal martin-gale measure. Finally we study mean-variance hedging, the variance-optimal martingale measure and the connections to closedness properties of spaces of stochastic integrals.

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What this paper is about

This paper gives an overview of results and developments in the area of pricing and hedging contingent claims in an incomplete market by means of a quadratic criterion. We first present the approach of risk-minimization in the case where the underlying discounted price process X is a local martingale. We then discuss the extension to local risk-minimization when X is a semimartingale and explain the relations to the Föllmer-Schweizer decomposition and the minimal martin-gale measure. Finally we study mean-variance hedging, the variance-optimal martingale measure and the connections to closedness properties of spaces of stochastic integrals.

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Available abstract

This paper gives an overview of results and developments in the area of pricing and hedging contingent claims in an incomplete market by means of a quadratic criterion. We first present the approach of risk-minimization in the case where the underlying discounted price process X is a local martingale. We then discuss the extension to local risk-minimization when X is a semimartingale and explain the relations to the Föllmer-Schweizer decomposition and the minimal martin-gale measure. Finally we study mean-variance hedging, the variance-optimal martingale measure and the connections to closedness properties of spaces of stochastic integrals.

Key concepts: Quadratic equation, Mathematical economics, Computer science, Economics, Econometrics, Mathematics, Mathematical optimization, Geometry

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