Hedging Options in a GARCH Environment: Testing the Term Structure of Stochastic Volatility Models
This paper develops a methodology for testing the term structure of volatility forecasts derived from stochastic volatility models, and implements it to analyze models of S&P 500 index volatility. Volatility models are compared by their ability to hedge options positions sensitive to the term structure of volatility. Overall, the most effective hedge is a Black-Scholes (BS) delta-gamma hedge, while the BS delta-vega hedge is the least effective. The most successful volatility hedge is GARCH components delta-gamma, suggesting that the GARCH components estimate of the term structure of volatility is most accurate. The success of the BS delta-gamma hedge may be due to mispricing in the options market over the sample period.
|Date of creation:||Dec 1994|
|Publication status:||Published as "Bayesian Analysis of Stochastic Volatility Models: Comment", JBES, Vol. 12, no. 4 (1994): 395-396.|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
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- Tim Bollerslev, 1986.
"Generalized autoregressive conditional heteroskedasticity,"
EERI Research Paper Series
EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
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