Stochastic Volatility: Risk Minimization and Model Risk

Christian-Oliver Ewald (), Rolf Poulsen and Klaus Reiner Schenk-Hoppé ()
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Rolf Poulsen: Department of Mathematical Sciences, University of Copenhagen

No 07-10, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: In this paper locally risk-minimizing hedge strategies for European-style contingent claims are derived and tested for a general class of stochastic volatility models. These strategies are as easy to implement as ordinary delta hedges, yet in realistic settings they produce markedly lower hedge errors. Our experimental investigations on model risk furthermore show that locally risk-minimizing hedges are robust with respect to parameter uncertainty as well as misspecifications of the stochastic volatility model.

Keywords: Locally risk-minimizing hedge; delta hedge; stochastic volatility; model risk (search for similar items in EconPapers)
JEL-codes: C90 G13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-rmg
Date: 2007-02

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Persistent link: http://EconPapers.repec.org/RePEc:chf:rpseri:rp0710

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