Model risk adjusted hedge ratios

Carol Alexander, Andreas Kaeck and Leonardo M. Nogueira

Journal of Futures Markets, 2009, vol. 29, issue 11, 1021-1049

Abstract: Most option pricing models assume all parameters except volatility are fixed; yet they almost invariably change on re‐calibration. This article explains how to capture the model risk that arises when parameters that are assumed constant have calibrated values that change over time and how to use this model risk to adjust the price hedge ratios of the model. Empirical results demonstrate an improvement in hedging performance after the model risk adjustment. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:1021–1049, 2009

Date: 2009
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