IDEAS home Printed from https://ideas.repec.org/p/kud/kuiefr/200502.html
   My bibliography  Save this paper

Static Replication and Model Risk: Razor's Edge or Trader's Hedge?

Author

Listed:
  • Morten Nalholm

    (Department of Finance, Copenhagen Business School)

  • Rolf Poulsen

    (Institute for Mathematical Sciences, University of Copenhagen)

Abstract

We investigate how sensitive a variety of dynamic and static hedge strategies for barrier options are to model risk. We find that using plain vanilla options to hedge barrier options offers considerable improvements over usual ?-hedges. Further, we show that the hedge portfolios involving options are relatively more sensitive to model risk, the Devil is in the detail, but that the degree of misspecification sensitivity is quite robust across commonly used models.

Suggested Citation

  • Morten Nalholm & Rolf Poulsen, 2005. "Static Replication and Model Risk: Razor's Edge or Trader's Hedge?," FRU Working Papers 2005/02, University of Copenhagen. Department of Economics. Finance Research Unit.
  • Handle: RePEc:kud:kuiefr:200502
    as

    Download full text from publisher

    File URL: http://www.econ.ku.dk/FRU/WorkingPapers/PDF/2005/2005_02.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Ellen R. McGrattan & Edward C. Prescott, 2003. "Average Debt and Equity Returns: Puzzling?," American Economic Review, American Economic Association, pages 392-397.
    2. Jason G. Cummins, 2005. "A New Approach to the Valuation of Intangible Capital," NBER Chapters,in: Measuring Capital in the New Economy, pages 47-72 National Bureau of Economic Research, Inc.
    3. A. Bhargava & L. Franzini & W. Narendranathan, 2006. "Serial Correlation and the Fixed Effects Model," World Scientific Book Chapters,in: Econometrics, Statistics And Computational Approaches In Food And Health Sciences, chapter 4, pages 61-77 World Scientific Publishing Co. Pte. Ltd..
    4. Amit Goyal & Ivo Welch, 2003. "Predicting the Equity Premium with Dividend Ratios," Management Science, INFORMS, pages 639-654.
    5. Fama, Eugene F, 1981. "Stock Returns, Real Activity, Inflation, and Money," American Economic Review, American Economic Association, pages 545-565.
    6. John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-Run Stock Market Outlook: An Update," NBER Working Papers 8221, National Bureau of Economic Research, Inc.
    7. Hulten, Charles R, 1975. "Technical Change and the Reproducibility of Capital," American Economic Review, American Economic Association, pages 956-965.
    8. Carlota Perez, 2002. "Technological Revolutions and Financial Capital," Books, Edward Elgar Publishing, number 2640, September.
    9. Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc.
    10. Megna, Pamela & Klock, Mark, 1993. "The Impact on Intangible Capital on Tobin's q in the Semiconductor Industry," American Economic Review, American Economic Association, pages 265-269.
    11. Dale W. Jorgenson, 2001. "Information Technology and the U.S. Economy," American Economic Review, American Economic Association, pages 1-32.
    12. Bipasa Datta & Huw D. Dixon, 2002. "Technological Change, Entry and Stock Market Dynamics: An Analysis of Transition in a Monopolistic Economy," CESifo Working Paper Series 641, CESifo Group Munich.
    13. Ravi Jagannathan & Ellen R. McGrattan & Anna Scherbina, 2000. "The declining U.S. equity premium," Quarterly Review, Federal Reserve Bank of Minneapolis, pages 3-19.
    14. Michael T. Kiley, 2000. "Stock prices and fundamentals in a production economy," Finance and Economics Discussion Series 2000-05, Board of Governors of the Federal Reserve System (U.S.).
    15. Donald Robertson & Stephen Wright, 2006. "Dividends, Total Cash Flow to Shareholders, and Predictive Return Regressions," The Review of Economics and Statistics, MIT Press, pages 91-99.
    16. Balvers, Ronald J & Cosimano, Thomas F & McDonald, Bill, 1990. " Predicting Stock Returns in an Efficient Market," Journal of Finance, American Finance Association, vol. 45(4), pages 1109-1128, September.
    17. Ravi Jagannathan & Ellen R. McGrattan & Anna Scherbina, 2000. "The declining U.S. equity premium," Quarterly Review, Federal Reserve Bank of Minneapolis, pages 3-19.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. repec:wsi:ijfexx:v:02:y:2015:i:03:n:s2424786315500231 is not listed on IDEAS

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:kud:kuiefr:200502. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Thomas Hoffmann). General contact details of provider: http://edirc.repec.org/data/okokudk.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.