There is no nontrivial hedging portfolio for option pricing with transaction costs. (English) Zbl 0837.90012

Summary: Conventional wisdom holds that since continuous-time, Black-Scholes hedging is infinitely expensive in a model with proportional transaction costs, there is no continuous-time strategy which hedges a European call option perfectly. Of course, if one is attempting to dominate the European call rather than replicate it, then one can use the trivial strategy of buying one share of the underlying stock and holding to maturity. In this paper, we prove that this is, in fact, the least expensive method of dominating a European call in a Black-Scholes model with proportional transaction costs.


91G20 Derivative securities (option pricing, hedging, etc.)
60H30 Applications of stochastic analysis (to PDEs, etc.)
93E20 Optimal stochastic control
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