An improved framework for approximating option prices with application to option portfolio hedging
M. Humayun Kabir and
Economic Modelling, 2016, vol. 59, issue C, 285-296
As the price of the underlying asset changes over time, delta of the option changes and a gamma hedge is required along with delta hedge to reduce risk. This paper develops an improved framework to compute delta and gamma values with the average of a range of underlying prices rather than at the conventional fixed ‘one point’. We find that models with time-varying volatility price options satisfactorily, and perform remarkably well in combination with the delta and delta-gamma approximations. Significant improvements are achieved for the GARCH model followed by stochastic volatility models. The new approach can ensure significant improvement in modelling option prices leading to better risk-management decision-making.
Keywords: Delta; Gamma; Hedge; Multi-stock-knot; Lévy pricing (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:59:y:2016:i:c:p:285-296
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