Abstract
AbstractThe price of a financial claim at a fixed time can represented by arandom variable H . In an incomplete market H can be approximatedby a trading strategy known as minimum variance hedging. Minimumvariance hedging can be extended to a mean-variance optimal strat-egy where a riskier trading strategy attempts to exploit the expecteddifference between the hedging strategy and the financial claim. Thispaper shows that any mean-variance optimal hedging strategy can bedecomposed into a sum of two conceptually and mathematically dif-ferent trades. One is the minimum variance hedging strategy and theother is the mean-variance optimal price ‘direction’ trading strategythat is independent of the hedging strategy and is only dependent onthe price of the asset used for hedging. General explicit optimal price‘direction’ strategies are also formulated.Keywords: Mean-Variance Optimal Hedging, Minimum VarianceHedging, Optimal Price Trading, Trade Separation, Variance Opti-mal Martingale Measure.JEL Codes: C61, G11.
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