Simulated Swaption Delta-Hedging in the Lognormal Forward Libor Model

32 Pages Posted: 9 May 2000

See all articles by Erik Schlögl

Erik Schlögl

University of Technology Sydney (UTS), Quantitative Finance Research Centre; University of Cape Town (UCT) - The African Institute of Financial Markets and Risk Management; Faculty of Science, Department of Statistics, University of Johannesburg; Financial Research Network (FIRN)

Tim Dun

ANZ Investment Bank

Geoff Barton

The University of Sydney

Date Written: February 2000

Abstract

Alternative approaches to hedging swaptions are explored and tested by simulation. Hedging methods implied by the Black swaption formula are compared with a lognormal forward LIBOR model approach encompassing all the relevant forward rates. The simulation is undertaken within the LIBOR model framework for a range of swaptions and volatility structures. Despite incompatibilities with the model assumptions, the Black method performs equally well as the LIBOR method, yielding very similar distributions for the hedging profit and loss - even at high rehedging frequencies. This result demonstrates the robustness of the Black hedging technique and implies that - being simpler and generally better understood by financial practitioners - it would be the preferred method in practice.

JEL Classification: G13

Suggested Citation

Schloegl, Erik and Dun, Tim and Barton, Geoff, Simulated Swaption Delta-Hedging in the Lognormal Forward Libor Model (February 2000). Available at SSRN: https://ssrn.com/abstract=215049 or http://dx.doi.org/10.2139/ssrn.215049

Erik Schloegl (Contact Author)

University of Technology Sydney (UTS), Quantitative Finance Research Centre ( email )

Ultimo
PO Box 123
Sydney, NSW 2007
Australia
+61 2 9514 2535 (Phone)

HOME PAGE: http://www.schlogl.com

University of Cape Town (UCT) - The African Institute of Financial Markets and Risk Management ( email )

Leslie Commerce Building
Rondebosch
Cape Town, Western Cape 7700
South Africa

Faculty of Science, Department of Statistics, University of Johannesburg ( email )

Auckland Park, 2006
South Africa

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Tim Dun

ANZ Investment Bank ( email )

Geoff Barton

The University of Sydney ( email )

Chemical Engineering
Sydney NSW 2006
Australia

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