Hedging

Hedging is an important consideration in modern finance. Whether or not to hedge, how much portfolio insurance is adequate, and how often to rebalance a portfolio are important considerations for traders, portfolio managers, and financial institutions alike.

If there were no transaction costs, financial professionals would prefer to rebalance portfolios continually, thereby minimizing exposure to market movements. However, in practice, the transaction costs associated with frequent portfolio rebalancing may be expensive. Therefore, traders and portfolio managers must carefully assess the cost required to achieve a particular portfolio sensitivity (for example, maintaining delta, gamma, and vega neutrality). Thus, the hedging problem involves the fundamental tradeoff between portfolio insurance and the cost of such insurance coverage.