Simple Robust Hedging with Nearby Contracts

54 Pages Posted: 2 Nov 2010

See all articles by Liuren Wu

Liuren Wu

City University of New York, CUNY Baruch College - Zicklin School of Business

Jingyi Zhu

University of Utah

Multiple version iconThere are 2 versions of this paper

Date Written: November 2, 2010

Abstract

Most existing hedging approaches are based on neutralizing risk exposures defined under a pre-specified model. This paper proposes a new, simple, and robust hedging approach based on the affinity of the derivative contracts. As a result, the strategy does not depend on assumptions on the underlying risk dynamics. Simulation analysis under commonly proposed security price dynamics shows that the hedging performance of our methodology based on a static position of three options compares favorably against the dynamic delta hedging strategy with daily rebalancing. A historical hedging exercise on S&P 500 index option further highlights the superior performance of our strategy.

Keywords: Options, Static Hedging, Forward Partial Differential Equation, Local Volatility

JEL Classification: E43, E47, G10, G12, C51

Suggested Citation

Wu, Liuren and Zhu, Jingyi, Simple Robust Hedging with Nearby Contracts (November 2, 2010). Available at SSRN: https://ssrn.com/abstract=1701696 or http://dx.doi.org/10.2139/ssrn.1701696

Liuren Wu (Contact Author)

City University of New York, CUNY Baruch College - Zicklin School of Business ( email )

One Bernard Baruch Way
Box B10-247
New York, NY 10010
United States
646-312-3509 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://faculty.baruch.cuny.edu/lwu/

Jingyi Zhu

University of Utah ( email )

1645 E. Campus Center
Salt Lake City, UT 84112
United States
801 581 3236 (Phone)

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