Mean-variance hedging and optimal investment in Heston's model with correlation

This paper solves the mean-variance hedging problem in Heston's model with a stochastic opportunity set moving systematically with the volatility of stock returns. We allow for correlation between stock returns and their volatility (so-called leverage effect). Our contribution is threefold: using a new concept of opportunity-neutral measure we present a simplified strategy for computing a candidate solution in the correlated case. We then go on to show that this candidate generates the true variance-optimal martingale measure; this step seems to be partially missing in the literature. Finally, we derive formulas for the hedging strategy and the hedging error.