Hedging Options in the Presence of Microstructural Noise

27 Pages Posted: 3 Mar 2008

See all articles by David Horn

David Horn

Goethe University Frankfurt - Department of Finance

Eva Schneider

Goethe University Frankfurt - Department of Finance

Grigory Vilkov

Frankfurt School of Finance & Management

Date Written: September 26, 2007

Abstract

In order to use an option pricing model for dynamic hedging an investor will have to calibrate it to a cross-section of option prices. Microstructural noise in option prices results in a set of indistinguishable parametrizations which may give rise to different hedging errors. In our simulation study for the Heston (1993) model, we identify the parameters most important for hedging and show which set of strikes and time to maturity is relevant for the identification of certain parameters. In our empirical study we show that different but indistinguishable parametrizations w.r.t. prices may induce large differences in hedging performance.

Keywords: parameter risk, hedging, microstructural noise, stochastic volatility

JEL Classification: G11, G12

Suggested Citation

Horn, David and Schneider, Eva and Vilkov, Grigory, Hedging Options in the Presence of Microstructural Noise (September 26, 2007). Available at SSRN: https://ssrn.com/abstract=1031342 or http://dx.doi.org/10.2139/ssrn.1031342

David Horn

Goethe University Frankfurt - Department of Finance ( email )

Gr├╝neburgplatz 1
Frankfurt am Main, 60323
Germany

Eva Schneider

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Grueneburgplatz 1
Frankfurt am Main, Hessen 60323
Germany
0049-(0)69-798-25178 (Phone)
0049-(0)69-798-22788 (Fax)

HOME PAGE: http://www.finance.uni-frankfurt.de/schlag/index.php?case=wimi2&men=2&id=503&lg=1

Grigory Vilkov (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

HOME PAGE: http://www.vilkov.net

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