Hedging Rainbow Options in Discrete Time

Abstract

A quadratic hedging strategy based on minimizing the hedging costs at each predetermined rebalancing time is used to hedge rainbow options. The corresponding hedging positions are simply obtained by solving a linear system, which is convenient for practical implementation. Quadratic hedging and the widely used delta hedging are compared to investigate their hedging performance for rainbow options in discrete time. By employing the Value-at-Risk (VaR) as the risk measure for comparing the hedging performance, simulation results indicate that the quadratic hedging performs better than the delta method in both static and dynamic scenarios.