Frey, Rüdiger. 2000. Market Illiquidities as a Source of Model Risk in Dynamic Hedging. In: Model Risk, Hrsg. Rajna Gibson, 125-138. London: Risk Publications.

RIS

@INBOOK{Frey2000,
title = {Market Illiquidities as a Source of Model Risk in Dynamic Hedging},
author = {Rüdiger Frey},
publisher = {Risk Publications},
year = {2000},
isbn = {1899332898},
address = {London},
publisher = {Risk Publications},
language = {EN},
pages = {125-138},
series = {Model Risk},
abstract = {In the present paper we study market illiquidity as a particular source of model risk in the hedging of derivatives. We depart from the usual Black-Scholes framework, where it is assumed that option hedgers are small traders, and consider a model where the implementation of a hedging strategy affects the price of the underlying security. We derive a formula for the feedback-effect of dynamic hedging on market volatility and present a formula for the hedging error due to market illiquidity. We go on and characterize perfect hedging strategies by a nonlinear version of the Black-Scholes PDE. We relate this PDE to other models for the risk-management of derivatives under market frictions and present some simulations.},
}