Simulated Swaption Delta-Hedging in the Lognormal Forward Libor Model

Tim Dunn, Erik Schlogl and Geoff Barton

No 40, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: Alternative approaches to hedging swaptions are explored and tested by simulation. Hedging methods implied by the Balck swaption formula are compared with a lognormal forward LIBOR model approach encompassing all the relevant forward rates. The simulation is undertaken within the LIBOR model framework for a range of swaptions and volatility structures. Despite incompatibilities with the model assumptions, the Black method performs equally well as the LIBOR method, yielding very similar distributions for the hedging profit and loss - even at high rehedging frequencies. This result demonstrates the robustness of the Black hedging technique and implies that - being simpler and generally better understood by financial practitioners - it would be the preferred method in practice.

Keywords: term structure of interest rates; hedging; simulation; lognormal forward LIBOR model (search for similar items in EconPapers)
Pages: 32 pages
Date: 2000-03-01
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Citations: View citations in EconPapers (8)

Published as: Dun, T., Barton, G. and Schlogl, E., 2001, "Swaption Delta-Hedging in the Lognormal Forward Libor Model", International Journal of Theoretical and Applied Finance, 4(4), 517-528.

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Related works:
Journal Article: SIMULATED SWAPTION DELTA–HEDGING IN THE LOGNORMAL FORWARD LIBOR MODEL (2001)
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