Hedging a Portfolio of Derivative Securities: A Simulation Approach

Claudio Tebaldi ()

Economic Notes, 2001, vol. 30, issue 2, 257-279

Abstract: type="main" xml:lang="en">

We illustrate a numerical simulation method to decompose a portfolio of derivative securities in a linear combination of dynamical risk factors. The price of the portfolio and its sensitivities are linear functions of these factors.

The method generalizes the static hedging theory proposed by Madan and Milne (1994) and applies to a dynamically complete, arbitrage free market with purely Brownian fluctuating assets. The extension to a class of market models whose volatility dynamics shows long memory and scaling behaviour is discussed and shown to be possible.

(J.E.L.: G12).

Date: 2001
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