Faculty of Economics and Business Administration Publications Database

Pitfalls in Static Superhedging of Barrier Option

Volume: 4
Number: 1
Pages: 2 - 9
Month: March
ISSN-Print: 1544-6123
Link External Source: Online Version
Year: 2007
Keywords: Down-and-out Call; Static Hedging; Local Time; Model Risk
Abstract: If the cost of carry is non-zero and only finitely many options are traded, static hedging of barrieroptions is in general impossible. Alternatively, one can set up a staticsuperhedging strategy. We demonstrate that such a superhedge may perform poorly close to the maturity of the barrieroption if the strikes of the options used to superhedge the barrieroption are not carefully chosen. Model risk amplifies this effect.