Robust static hedging of barrier options in stochastic volatility models

J. Maruhn () and E. Sachs ()

Mathematical Methods of Operations Research, 2009, vol. 70, issue 3, 405-433

Abstract: Static hedge portfolios for barrier options are extremely sensitive with respect to changes of the volatility surface. In this paper we develop a semi-infinite programming formulation of the static super-replication problem in stochastic volatility models which allows to robustify the hedge against model parameter uncertainty in the sense of a worst case design. From a financial point of view this robustness guarantees the hedge performance for an infinite number of future volatility surface scenarios including volatility shocks and changes of the skew. After proving existence of such robust hedge portfolios and presenting an algorithm to numerically solve the underlying optimization problem, we apply the approach to a detailed example. Surprisingly, the optimal robust portfolios are only marginally more expensive than the barrier option itself. Copyright Springer-Verlag 2009

Keywords: Robust optimization; Static hedging; Barrier options; Stochastic volatility; 91B28; 90C30; 90C34 (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s00186-008-0273-2

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