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Hedging Maturity-Specific Risk in Forward Curve Derivatives under Stochastic Volatility

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  • Riccardo Alberti
  • Sven Karbach

Abstract

We study the variance-optimal hedging of European contingent claims written on forwards. We assume that the dynamics of the underlying forward curves follow a Heath--Jarrow--Morton--Musiela stochastic partial differential equation modulated by an infinite-rank stochastic covariance component. The variance-optimal hedge is then given by the Galtchouk--Kunita--Watanabe projection with respect to some covariance-norm quotient generated by the forward curve martingale. We show density of finite-maturity and delivery-window strategies, convergence of spectral finite-rank hedge projections and an exact decomposition of the quadratic hedging error into bucket, rank and residual risk components. In enlarged filtrations, the residual risk is a stochastic-volatility floor for claims loading on non-traded covariance noise. We illustrate the hedging framework in affine stochastic covariance and multiplicative HJMM models, and give a concrete example of the decomposition in a CIR stochastic covariance model.

Suggested Citation

  • Riccardo Alberti & Sven Karbach, 2026. "Hedging Maturity-Specific Risk in Forward Curve Derivatives under Stochastic Volatility," Papers 2606.28891, arXiv.org.
    • Handle: RePEc:arx:papers:2606.28891
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

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