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Understanding Delta-Hedged Option Returns in Stochastic Volatility Environments

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  • Hiroshi Sasaki

Abstract

In this paper, we provide a novel representation of delta-hedged option returns in a stochastic volatility environment. The representation of delta-hedged option returns provided in this paper consists of two terms: volatility risk premium and parameter estimation risk. In an empirical analysis, we examine delta-hedged option returns based on the result of a historical simulation with the USD-JPY currency option market data from October 2003 to June 2010. We find that the delta-hedged option returns for OTM put options are strongly affected by parameter estimation risk as well as the volatility risk premium, especially in the post-Lehman shock period. Copyright Springer Japan 2015

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  • Hiroshi Sasaki, 2015. "Understanding Delta-Hedged Option Returns in Stochastic Volatility Environments," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 22(2), pages 151-184, May.
    • Handle: RePEc:kap:apfinm:v:22:y:2015:i:2:p:151-184
    DOI: 10.1007/s10690-014-9198-3
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