A Note on the Valuation and Hedging of Equity Swaps
THE J. OF FINANCIAL ENGINEERING, Vol. 4 No. 4, December 1995
Posted: 13 Jul 1998
Abstract
The uses and mechanics of an equity swap are now fairly straightforward, but the pricing and hedging implications are still less obvious. This article develops a simple approach to the pricing and hedging of equity swaps. It is shown that an equity swap can be viewed as a portfolio of forward start, forward equity contracts. This key insight allows one to write the equilibrium swap coupon rate in a surprisingly simple form, one that does not require knowledge of future equity prices. In fact, the framework incorporates price risk and interest rate risk with all of the variables in the final solution being directly observable, except for future spot interest rates.
JEL Classification: D58
Suggested Citation: Suggested Citation