A New Scheme for Static Hedging of European Derivatives under Stochastic Volatility Models

Akihiko Takahashi and Akira Yamazaki
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Akihiko Takahashi: Faculty of Economics, University of Tokyo
Akira Yamazaki: Mizuho-DL Financial Technology Co., Ltd.

No CIRJE-F-567, CIRJE F-Series from CIRJE, Faculty of Economics, University of Tokyo

Abstract: This paper proposes a new scheme for static hedging of European path-independent derivatives under stochastic volatility models. First, we show that pricing European path-independent derivatives under stochastic volatility models is transformed to pricing those under one-factor local volatility models. Next, applying an efficient static replication method for one-dimensional price processes developed by Takahashi and Yamazaki[2007], we present a static hedging scheme for European path-independent derivatives. Finally, a numerical example comparing our method with a dynamic hedging method under the Heston[1993]'s stochastic volatility model is used to demonstrate that our hedging scheme is effective in practice.

Pages: 22 pages
Date: 2008-06
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