Pricing and Hedging of the European Option Linked to Target Volatility Portfolio

38 Pages Posted: 8 Mar 2016

See all articles by Hassan Jawaid

Hassan Jawaid

Aarhus University - Department of Business and Economics

Date Written: August 1, 2015

Abstract

Advanced risk management strategies have become popular since they protect the investor's investment from market crashes. The latest risk management strategy is called the target volatility strategy. The target volatility strategy is used in order to maintain a stable realized volatility of a portfolio. The strategy re-balances the allocation of risky asset to non-risky asset in order to protect the portfolio from equity market crashes. This paper provides an extensive analysis of the target volatility portfolios and financial derivatives linked to target volatility portfolios. We demonstrate the performance of target volatility portfolios under different financial models. We also examine the effects of re-balancing frequencies on target volatility portfolios. We focus on the pricing and hedging of the European option linked to target volatility portfolios. In particular, we investigate the impact of stochastic equity asset volatility on the pricing and hedging of the European option linked to target volatility portfolios. We also consider different dynamic hedging strategies and compare their performance.

Keywords: Target volatility portfolio, stochastic volatility, re-balance frequency, EWMA method

Suggested Citation

Jawaid, Hassan, Pricing and Hedging of the European Option Linked to Target Volatility Portfolio (August 1, 2015). Available at SSRN: https://ssrn.com/abstract=2743699 or http://dx.doi.org/10.2139/ssrn.2743699

Hassan Jawaid (Contact Author)

Aarhus University - Department of Business and Economics ( email )

Fuglesangs Alle 4
Aarhus, 8210
Denmark

HOME PAGE: http://pure.au.dk/portal/da/persons/id(6ab1fbee-1408-405e-8ec2-14db329aed74).html

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