Many exotic options involve a payoff that occurs at the first time the stock price crosses a constant barrier. Although the amount to be paid is known, the time at which it is paid is not. This article shows how a static position in European options can be used to hedge against this timing risk. The simulation results show that this approach outperforms dynamic hedging with the underlying. The authors show how these results can be used to price any barrier option.
ASJC Scopus subject areas
- Economics and Econometrics