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The Trading Performance of Dynamic Hedging Models: Time Varying Covariance and Volatility Transmission Effects

Listed author(s):
  • Michael T. Chng
  • Gerard L. Gannon


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    In 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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    Paper 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.

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    Date of creation: 05 Aug 2009
    Handle: RePEc:dkn:acctwp:aef_2009_02
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