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Performance Of Robust Hedges For Digital Double Barrier Options

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  • JAN OBŁÓJ

    ()
    (Mathematical Institute and Oxford-Man Institute of Quantitative Finance, University of Oxford, 24-29 St Giles, Oxford OX1 3LB, UK)

  • FRÉDÉRIK ULMER

    ()

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    Abstract

    We analyze the performance of robust hedging strategies of digital double barrier options of Cox and Obłój (2011) against that of traditional hedging methods such as delta and delta/vega hedging. Digital double barrier options are financial derivative contracts which pay out a fixed amount on the condition that the underlying asset remains within or breaks into a range defined by two distinct barrier levels. We perform the analysis in hypothetical forward markets driven by models with stochastic volatility and jumps, calibrated to the AUD/USD foreign exchange rate market. Our findings are strikingly unanimous and suggest that, in the presence of model uncertainty and/or transaction costs, robust hedging strategies typically outperform in a substantial way model-specific hedging methods.

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    Bibliographic Info

    Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

    Volume (Year): 15 (2012)
    Issue (Month): 01 ()
    Pages: 1250003-1-1250003-34

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    Handle: RePEc:wsi:ijtafx:v:15:y:2012:i:01:p:1250003-1-1250003-34

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    Related research

    Keywords: Robust hedging; evaluation of hedging strategies; Skorokhod embedding; digital double barrier option;

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