Adaptive Mean-Variance Hedging of Bond Options with Stochastic Risk Term

Abstract

We consider the adaptive mean-variance hedging problem for pricing bond options . The model considered contains infinite-dimensional noise sources with the stochastically-varying risk premium. Hence our model becomes incomplete. After constructing the adaptive estimation algorithm for risk premium and systems parameters, we study the adaptive mean-variance hedging problem under the real world measure and obtain an explicit form of the optimal hedging strategy.