Calibration and hedging under jump diffusion

C. He (), J. Kennedy (), T. Coleman (), P. Forsyth (), Y. Li () and K. Vetzal ()

Review of Derivatives Research, 2006, vol. 9, issue 1, 35 pages

Abstract: A jump diffusion model coupled with a local volatility function has been suggested by Andersen and Andreasen (2000). By generating a set of option prices assuming a jump diffusion with known parameters, we investigate two crucial challenges intrinsic to this type of model: calibration of parameters and hedging of jump risk. Even though the estimation problem is ill-posed, our results suggest that the model can be calibrated with sufficient accuracy. Two different strategies are explored for hedging jump risk: a semi-static approach and a dynamic technique. Simulation experiments indicate that each of these methods can sharply reduce risk exposure. Copyright Springer Science+Business Media, LLC 2006

Keywords: Jump diffusion; Calibration; Static hedging; Dynamic hedging (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (22)

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DOI: 10.1007/s11147-006-9003-1

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