Hedging Futures Options with Stochastic Interest Rates
27 Pages Posted: 20 Sep 2016
Date Written: September 19, 2016
This paper presents a simulation study of hedging long-dated futures options, in the Rabinovitch (1989) model which assumes correlated dynamics between spot asset prices and interest rates. Under this model and when the maturity of the hedging instruments match the maturity of the option, forward contracts and futures contracts can hedge both the market risk and the interest rate risk of the options positions. When the hedge is rolled forward with shorter maturity hedging instruments, then bond contracts are additionally required to hedge the interest rate risk. This requirement becomes more pronounced for longer maturity contracts and amplifies as the interest rate volatility increases. Factor hedging ratios are also considered, which are suited for multi-dimensional models, and their numerical efficiency is validated.
Keywords: Futures options, Stochastic interest rates, Delta hedging, Interest rate hedging
JEL Classification: C60, G13
Suggested Citation: Suggested Citation