Hedging Futures Options with Stochastic Interest Rates

27 Pages Posted: 20 Sep 2016

See all articles by Benjamin Cheng

Benjamin Cheng

University of Technology Sydney (UTS), UTS Business School, Students

Christina Sklibosios Nikitopoulos

University of Technology Sydney - Business School; Financial Research Network (FIRN)

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)

Date Written: September 19, 2016

Abstract

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

Cheng, Benjamin and Sklibosios Nikitopoulos, Christina and Schloegl, Erik, Hedging Futures Options with Stochastic Interest Rates (September 19, 2016). Available at SSRN: https://ssrn.com/abstract=2840635 or http://dx.doi.org/10.2139/ssrn.2840635

Benjamin Cheng

University of Technology Sydney (UTS), UTS Business School, Students ( email )

Sydney
Australia

Christina Sklibosios Nikitopoulos (Contact Author)

University of Technology Sydney - Business School ( email )

15 Broadway, Ultimo
Sydney 2007, New South Wales
Australia

Financial Research Network (FIRN)

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

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

Erik Schloegl

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

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
85
Abstract Views
808
rank
330,306
PlumX Metrics