Hedging Portfolios of Financial Guarantees

34 Pages Posted: 14 Feb 2009

See all articles by Van Son Lai

Van Son Lai

Université Laval

Yves Langlois

affiliation not provided to SSRN

Issouf Soumaré

Laval University

Date Written: February, 13 2009


We propose a framework a la Davis et al. (1993) and Whalley and Wilmott (1997) to study dynamic hedging strategies on portfolios of financial guarantees in the presence of transaction costs. We contrast four dynamic hedging strategies including a utility-based dynamic hedging strategy, in conjunction with using an asset-based index, with the strategy of no hedging. For the proposed utility-based strategy, the portfolio rebalancing is triggered by the tradeoff between transaction costs and utility gains. Overall, using a Froot and Stein (1998) and Perold (2005) type of risk-adjusted performance measurement metric, we find the utility-based strategy to be a good compromise between the delta hedging strategy and the passive stance of doing nothing. This result is even stronger with higher transaction costs. However, if the insured firms assets are not traded or in a high transaction costs environment, the guarantor can use an index-based security as hedging instrument.

Keywords: Financial guarantee, Credit insurance, Dynamic hedging, Portfolio replication

JEL Classification: G11, G13, G22

Suggested Citation

Lai, Van Son and Langlois, Yves and Soumaré, Issouf, Hedging Portfolios of Financial Guarantees (February, 13 2009). Journal of Risk, Vol. 11, No. 2, 2008-2009. Available at SSRN: https://ssrn.com/abstract=1342478

Van Son Lai

Université Laval ( email )

FSA ULaval
Quebec G1V 0A6
418-656-2131, x3943 (Phone)

Yves Langlois

affiliation not provided to SSRN ( email )

Issouf Soumaré (Contact Author)

Laval University ( email )

Faculty of Business Administration
Department of Finance, Insurance and Real Estate
Quebec, Quebec G1V 0A6
1418 656 3423 (Phone)
1418 656 2624 (Fax)

Register to save articles to
your library


Paper statistics

Abstract Views
PlumX Metrics