A Robust Approach to Hedging and Pricing in Imperfect Markets

Abstract

This paper proposes a model-free 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 with a wide family of risk measures and pricing rules, and study the conditions under which the hedging problem admits a solution and pricing is possible. The practical implications of our proposed theoretical approach are illustrated with an application on hedging economic risk.

Keywords

• imperfect markets
• risk measures
• hedging
• pricing rule
• quantile regression