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Stochastic Volatility: Risk Minimization and Model Risk


Author Info

  • Christian-Olivier Ewald

    (School of Mathematics, University of Leeds)

  • Rolf Poulsen

    (Department of Mathematical Sciences, University of Copenhagen)

  • Klaus Reiner Schenk-Hoppe

    (School of Mathematics and Leeds University Business School, University of Leeds)


In this paper locally risk-minimizing hedge strategies for European-style contingent claims are derived and tested for a general class of stochastic volatility models. These strategies are as easy to implement as ordinary delta hedges, yet in realistic settings they produce markedly lower hedge errors. Our experimental investigations on model risk furthermore show that locally risk-minimizing hedges are robust with respect to parameter uncertainty as well as misspecifications of the stochastic volatility model.

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Bibliographic Info

Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 07-10.

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Length: 18 pages
Date of creation: Feb 2007
Date of revision:
Handle: RePEc:chf:rpseri:rp0710

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Related research

Keywords: Locally risk-minimizing hedge; delta hedge; stochastic volatility; model risk;

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