JOURNAL OF DERIVATIVES Vol 2 No 4
Posted: 10 Oct 1998
This article addresses the issue of hedging options positions when the underlying asset exhibits stochastic volatility. By parameterizing the volatility process as GARCH, and utilizing risk-neutral valuation, we approximate hedging parameters (delta and gamma) using Monte Carlo simulation. We estimate hedging parameters for options on the Standard & Poor's 500 index, a bond futures index, a weighted foreign exchange rate index, and an oil futures index.We find that Black-Scholes and GARCH deltas are similar for all the options considered, while GARCH gammas are significantly higher than BS gammas for all options. For near-the-money options, GARCH gamma hedge ratios are higher than BS hedge ratios when hedging a long-term option with a short-term option. Away from the money, GARCH gamma hedge ratios are lower than BS.
JEL Classification: G13
Suggested Citation: Suggested Citation