Hedging in Illiquid Markets

Hedging financial risk is one of the key tasks in investment banking and requires sophisticated mathematical methods to be carried out systematically and efficiently. Most models used for this purpose, however, disregard that hedging strategies themselves may move prices when markets are not perfectly liquid and thus may fail to include liquidity risk when computing prices and hedge ratios; see Gökay, Roch, Soner (2010) for an overview. Recent work by Bank and Kramkov (2011a, b, c) has developed a new framework for incorporating the long term market impact of trading strategies in a systematic way which allows, for instance, for the computation of liquidity adjusted Black-Scholes hedges or the valuation of contingent claims when taking into account the market's risk bearing abilities.

Selected Publications