An Analysis of the Risk in Discretely Rebalanced Option Hedges and Delta-Based Techniques
AbstractThe stochastic properties of discretely rebalanced option hedges have been studied extensively beginning with Black and Scholes (1973). In each analysis hedges were "delta-neutral" after rebalancing. We argue that the distributional properties of discretely rebalanced hedges are such that delta-based hedging is not the variance minimizing strategy. This paper obtains analytical expressions for the variance minimizing option hedge ratios. We also evaluate the hedge variance to assess the magnitude of the variance reduction over delta-based hedges. For representative parameter values, we show that systematic departures from delta-based hedges can yield significant reductions in hedge variance even for one day rebalancing intervals.
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Bibliographic InfoArticle provided by INFORMS in its journal Management Science.
Volume (Year): 40 (1994)
Issue (Month): 6 (June)
hedge; option; delta; discrete rebalancing;
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