Hedging error measurement for imperfect strategies

Jack Baczynski, Allan Jonathan da Silva and Estevão Rosalino Junior introduce a criterion for measuring the hedging error. It gives information of the quality of the hedging strategy and allows comparison among strategies across different products and markets. Simulations show that the classical measure and this measure are complementary and their concomitant use benefits the financial industry

A hedging strategy is intended to eliminate the exposure of the practitioner that holds a short or long position in a financial derivative security via a portfolio that replicates pointwise the value of the derivative at the maturity time T (see, for example, Hull 2003). In practice, trading times and observation times of market prices are discrete and trading occurs in incomplete markets. Any of these motives suffice to render the hedging strategies imperfect, so that a hedging error e_T arises