Dynamic Hedging of Financial Instruments When the Underlying Follows a Non-Gaussian Process
AbstractTraditional dynamic hedging strategies are based on local information (ie Delta and Gamma) of the financial instruments to be hedged. We propose a new dynamic hedging strategy that employs non-local information and compare the profit and loss (P&L) resulting from hedging vanilla options when the classical approach of Delta- and Gammaneutrality is employed, to the results delivered by what we label Delta- and Fractional-Gamma-hedging. For specific cases, such as the FMLS of Carr and Wu (2003a) and Merton’s Jump-Diffusion model, the volatility of the P&L is considerably lower (in some cases only 25%) than that resulting from Delta- and Gamma-neutrality.
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Bibliographic InfoPaper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0508.
Date of creation: May 2005
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-05-29 (All new papers)
- NEP-FIN-2005-05-29 (Finance)
- NEP-RMG-2005-05-29 (Risk Management)
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