Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/239513 
Year of Publication: 
2021
Citation: 
[Journal:] Journal of Risk and Financial Management [ISSN:] 1911-8074 [Volume:] 14 [Issue:] 3 [Publisher:] MDPI [Place:] Basel [Year:] 2021 [Pages:] 1-19
Publisher: 
MDPI, Basel
Abstract: 
In this paper we propose a maximum entropy estimator for the asymptotic distribution of the hedging error for options. Perfect replication of financial derivatives is not possible, due to market incompleteness and discrete-time hedging. We derive the asymptotic hedging error for options under a generalised jump-diffusion model with kernel bias, which nests a number of very important processes in finance. We then obtain an estimation for the distribution of hedging error by maximising Shannon's entropy subject to a set of moment constraints, which in turn yields the value-at-risk and expected shortfall of the hedging error. The significance of this approach lies in the fact that the maximum entropy estimator allows us to obtain a consistent estimate of the asymptotic distribution of hedging error, despite the non-normality of the underlying distribution of returns.
Subjects: 
expected shortfall
value-at-risk
asymptotic hedging error
esscher transform
generalised jump
kernel biased
maximum entropy density
JEL: 
C13
C51
G13
Persistent Identifier of the first edition: 
Creative Commons License: 
cc-by Logo
Document Type: 
Article

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