Hedging Derivatives Risks - a Simulation Study

46 Pages Posted: 20 Mar 2002

See all articles by Roel C. A. Oomen

Roel C. A. Oomen

Deutsche Bank AG (London); London School of Economics & Political Science (LSE) - Department of Statistics

George J. Jiang

Washington State University

Date Written: September 2001

Abstract

This paper undertakes a simulation study to investigate (a) the performance of alternative hedging strategies against various derivatives risks and (b) the impact of model misspecification on hedging performance. The hedging strategies considered in this paper include the single-instrument hedge, the delta-neutral hedge, and the ad hoc Black-Scholes delta-vega-(rho)-neutral hedge, while the risk factors of the derivatives include the underlying asset return risk, stochastic volatility risk, stochastic interest rate risk, and random jump or market crash risk. In addition, we investigate the performance of the delta-neutral hedge with the use of potentially traded volatility derivatives. Our simulation results provide guidance for how a risk factor can be hedged based on certain hedging strategies and evidence of how severe model risk can be when hedging strategies are based on misspecified models.

Keywords: Derivatives Risks, Model Risk, Hedging Strategies, Hedging Performance, Simulation Study

JEL Classification: C0, C1, C6, G0

Suggested Citation

Oomen, Roel C.A. and Jiang, George, Hedging Derivatives Risks - a Simulation Study (September 2001). Available at SSRN: https://ssrn.com/abstract=302525 or http://dx.doi.org/10.2139/ssrn.302525

Roel C.A. Oomen (Contact Author)

Deutsche Bank AG (London) ( email )

Winchester House
1 Great Winchester Street
London, EC2N 2DB
United Kingdom

London School of Economics & Political Science (LSE) - Department of Statistics ( email )

Houghton Street
London, England WC2A 2AE
United Kingdom

George Jiang

Washington State University ( email )

Department of Finance and Management Science
Carson College of Business
Pullman, WA 99-4746164
United States
509-3354474 (Phone)

HOME PAGE: http://directory.business.wsu.edu/bio.html?username=george.jiang

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