The Trading Performance of Dynamic Hedging Models: Time Varying Covariance and Volatility Transmission Effects
AbstractIn this paper, we investigate the value of incorporating implied volatility from related option markets in dynamic hedging. We comprehensively model the volatility of all four S&P 500 cash, futures, index option and futures option markets simultaneously. Synchronous half-hourly observations are sampled from transaction data. Special classes of extended simultaneous volatility systems (ESVL) are estimated and used to generate out-of-sample hedge ratios. In a hypothetical dynamic hedging scheme, ESVLbased hedge ratios, which incorporate incremental information in the implied volatilities of the two S&P 500 option markets, generate profits from interim rebalancing of the futures hedging position that are incremental over competing hedge ratios. In addition, ESVL-based hedge ratios are the only hedge ratios that manage to generate sufficient profit during the hedging period to cover losses incurred by the physical portfolio .
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Bibliographic InfoPaper provided by Deakin University, Faculty of Business and Law, School of Accounting, Economics and Finance in its series Accounting, Finance, Financial Planning and Insurance Series with number 2009_02.
Date of creation: 05 Aug 2009
Date of revision:
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volatility transmission; dynamic hedging; optimal hedge ratio; S&P 500;
Find related papers by JEL classification:
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
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