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Static Hedging of Defaultable Contingent Claims: A Simple Hedging Scheme Across Equity and Credit Markets

33 Pages Posted: 12 May 2009 Last revised: 20 Apr 2011

Shuichi Ohsaki

Merrill Lynch & Co.

Akira Yamazaki

Hosei University - Graduate School of Business Administration

Date Written: May 12, 2009

Abstract

This paper proposes a simple scheme for static hedging of defaultable contingent claims. It is a kind of generalization of the technique developed by Carr and Chou (1997), Carr and Madan (1998), and Takahashi and Yamazaki (2009a) into unified credit-equity modelings. Our scheme provides a hedging strategy across credit and equity markets, where any defaultable contingent claim is accurately replicated by a feasible number of plain vanilla equity options. Another point is that shorter maturity options are available to hedge longer maturity defaultable contingent claims. Through numerical examples, it is shown that the scheme is applicable to both structural and intensity-based models.

Keywords: Static hedging, Default risk, Equity options, Defaultable bonds, Structural model, Intensity-based model

JEL Classification: G13, G14, G33

Suggested Citation

Ohsaki, Shuichi and Yamazaki, Akira, Static Hedging of Defaultable Contingent Claims: A Simple Hedging Scheme Across Equity and Credit Markets (May 12, 2009). International Journal of Theoretical and Applied Finance, Vol. 14, No. 2, 2011. Available at SSRN: https://ssrn.com/abstract=1403064

Shuichi Ohsaki (Contact Author)

Merrill Lynch & Co.

Tokyo
Japan

Akira Yamazaki

Hosei University - Graduate School of Business Administration ( email )

Japan

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