Stefan Sandberg: Liquidity in Equity and Option Markets - A Hedging Perspective

When options and other derivatives are issued, the issuer seeks risk neutral positions. These positions are obtained through an analysis of the sensitivity of the derivative's price with respect to the targeted parameters. Risk neutral positions acquire a time continuous price process as a good proxy to ensure more or less explicit hedging costs. This thesis describes what happens with the hedging costs if the price process is not continuous or if there is a discrete event (a jump) between time zero and maturity. We show how much the hedging cost increases and for which positions the issuer is most vulnerable, and how the profit and loss deviation increases for discontinuous processes. We document for the importance of no major jumps in the underlying time process, when hedging.