Interest Rate Risk Hedging Demand Under a Gaussian Framework
9 Pages Posted: 6 Feb 2010
Date Written: February 4, 2010
This article analyzes the state variables Merton-Breeden hedging demand for an investor endowed with a utility function over both intermediate consumption and terminal wealth. Based on the three-factor model of Babbs and Nowman (1999), we show that this demand can be simply expressed as weighted average zero-coupon bonds sensitivities to these factors. The weighting parameter is actually the proportion of wealth our investor sets aside for future consumption rather than for terminal wealth.
Keywords: Merton-Breeden hedging demand, interest rate risk, expected utility maximization, intermediate consumption, terminal wealth
JEL Classification: G13
Suggested Citation: Suggested Citation