A Comparison of Pricing and Hedging Performances of Equity Derivatives Models

15 Pages Posted: 17 Jul 2017 Last revised: 5 Jan 2018

See all articles by Nathan Lassance

Nathan Lassance

UCLouvain - UCLouvain, Louvain School of Management - Louvain Finance

Frédéric D. Vrins

Louvain Finance Center (LFIN), UC Louvain; Center for Operations Research and Econometrics (CORE), UC Louvain

Date Written: July 11, 2017

Abstract

This paper investigates the pricing/hedging conundrum, i.e. the observation of a mismatch between derivatives models’ pricing and hedging performances, that has so far been under-emphasized as the literature tends to focus on increasingly complicated option pricing models, without adequately addressing hedging performance. Hence, we analyze the ability of the Black-Scholes, Practitioner Black-Scholes, Heston-Nandi and Heston models to Deltahedge a set of call options on the S&P500 index and Apple stock. We extend earlier studies in that we consider the impact of asset dynamics, apply a stringent payoff replication strategy, look at the impact of moneyness at maturity and test for the robustness to the parameters’ calibration frequency and Delta-Vega hedging. The study shows that adding risk factors to a model, such as stochastic volatility, should only be considered in light of the data dynamics. Even then, however, more complicated models generally fare poorly for hedging purposes. Hence, a better fit of a model to option prices is not a good indicator of its hedging performance, and so of its ability to describe the underlying dynamics. This can be understood for reasons of over-fitting. Those findings hint to a potentially appealing hedging-based calibration of models’ parameters, rather than the standard pricing-based one.

Keywords: Option Pricing, Dynamic Hedging, Stochastic Volatility, Payoff Replication, Calibration

JEL Classification: G12, G13

Suggested Citation

Lassance, Nathan and Vrins, Frederic Daniel, A Comparison of Pricing and Hedging Performances of Equity Derivatives Models (July 11, 2017). Applied Economics, Volume 50, Issue 10, pp. 1122-1137. Available at SSRN: https://ssrn.com/abstract=3000405 or http://dx.doi.org/10.2139/ssrn.3000405

Nathan Lassance (Contact Author)

UCLouvain - UCLouvain, Louvain School of Management - Louvain Finance ( email )

voie du roman, 34
Louvain-la-neuve, 1348
Belgium

Frederic Daniel Vrins

Louvain Finance Center (LFIN), UC Louvain ( email )

Voie du Roman Pays 34
Louvain-la-Neuve, 1348
Belgium

HOME PAGE: http://www.uclouvain.be/frederic.vrins

Center for Operations Research and Econometrics (CORE), UC Louvain ( email )

Voie du Roman Pays 34
Louvain-la-Neuve,, B-1348
Belgium

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
84
Abstract Views
435
rank
310,297
PlumX Metrics