Johannes Sivén presents his Licentiate thesis

Risk-minimizing Static Hedges of Barrier Options

Abstract

We present a method for computing risk-minimizing static hedge
strategies (Paper A).  The method is straightforward, yet flexible
with respect to the type of contingent claim being hedged, the choice
of risk-measure, and the underlying asset dynamics. Experimental
investigations for barrier options show that in a stochastic
volatility model with jumps the resulting hedges outperform previous
suggestions in the literature. We also illustrate that the
risk-minimizing static hedges work in an infinite intensity
Levy-driven model, and that the performance of the hedges is robust to
model risk. In Paper B we extend the method and fill a hole in the
literature by investigating static hedging of barrier options with
plain vanilla in the presence of realistic bid/ask spreads. Spreads
for options are  much larger than for the underlying, and this levels
the playing field in relation to traditional dynamic hedging. However,
hedging with options is still the best way to reduce the risk of large
losses.