Pricing and hedging basis risk under no good deal assumption

Abstract

We consider the problem of explicitly pricing and hedging an option written on a non-exchangeable asset when trading in a correlated asset is possible. This is a typical case of incomplete market where it is well known that the super-replication concept provides generally too high prices. We study several prices and in particular the instantaneous no-good-deal price (see Cochrane and Saa-Requejo in J Polit Econ 108(1):79–119, 2001) and the global one. We show numerically that the global no-good-deal price can be significantly higher that the instantaneous one. We then propose several hedging strategies and show numerically that the mean-variance hedging strategy can be efficient.