Risk Measure Approaches to Partial Hedging and Reinsurance
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Hedging has been one of the most important topics in finance. How to effectively hedge the exposed risk draws significant interest from both academicians and practitioners. In a complete financial market, every contingent claim can be hedged perfectly. In an incomplete market, the investor can eliminate his risk exposure by superhedging. However, both perfect hedging and superhedging usually call for a high cost. In some situations, the investor does not have enough capital or is not willing to spend that much to achieve a zero risk position. This brings us to the topic of partial hedging. In this thesis, we establish the risk measure based partial hedging model and study the optimal partial hedging strategies under various criteria. First, we consider two of the most common risk measures known as Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR). We derive the analytical forms of optimal partial hedging strategies under the criterion of minimizing VaR of the investor's total risk exposure. The knock-out call hedging strategy and the bull call spread hedging strategy are shown to be optimal among two admissible sets of hedging strategies. Since VaR risk measure has some undesired properties, we consider the CVaR risk measure and show that bull call spread hedging strategy is optimal under the criterion of minimizing CVaR of the investor's total risk exposure. The comparison between our proposed partial hedging strategies and some other partial hedging strategies, including the well-known quantile hedging strategy, is provided and the advantages of our proposed partial hedging strategies are highlighted. Then we apply the similar approaches in the context of reinsurance. The VaR-based optimal reinsurance strategies are derived under various constraints. Then we study the optimal partial hedging strategies under general risk measures. We provide the necessary and sufficient optimality conditions and use these conditions to study some specific hedging strategies. The robustness of our proposed CVaR-based optimal partial hedging strategy is also discussed in this part. Last but not least, we propose a new method, simulation-based approach, to formulate the optimal partial hedging models. By using the simulation-based approach, we can numerically obtain the optimal partial hedging strategy under various constraints and criteria. The numerical results in the examples in this part coincide with the theoretical results.
Cite this version of the work
Jianfa Cong (2014). Risk Measure Approaches to Partial Hedging and Reinsurance. UWSpace. http://hdl.handle.net/10012/8163