Hedging and Pricing in Imperfect Markets under Non-Convexity

Hirbod Assa and Nikolay Gospodinov
Working Paper 2014-13
August 2014

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This paper proposes a robust approach to hedging and pricing in the presence of market imperfections such as market incompleteness and frictions. The generality of this framework allows us to conduct an in-depth theoretical analysis of hedging strategies for a wide family of risk measures and pricing rules, which are possibly non-convex. The practical implications of our proposed theoretical approach are illustrated with an application on hedging economic risk.

JEL classification: G11, G13, C22, E44

Key words: imperfect markets, risk measures, hedging, pricing rule, quantile regression

The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Hirbod Assa, Institute for Financial and Actuarial Mathematics, University of Liverpool, Mathematical Sciences Building, Peach Street, Liverpool L69 7ZL, United Kingdom, h.assa@liverpool.ac.uk; or Nikolay Gospodinov, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, 404-498-7892, nikolay.gospodinov@atl.frb.org.

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