STATIC HEDGING OF DEFAULTABLE CONTINGENT CLAIMS: A SIMPLE HEDGING SCHEME ACROSS EQUITY AND CREDIT MARKETS

Shuichi Ohsaki () and Akira Yamazaki ()
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Shuichi Ohsaki: Barclays Capital Inc., 6-10-1, Roppongi, Minato-ku, Tokyo 106-6131, Japan
Akira Yamazaki: Graduate School of Economics, University of Tokyo, 7-3-1 Hongo, Bunkyo-ku, Tokyo, 113-0033, Japan;

International Journal of Theoretical and Applied Finance (IJTAF), 2011, vol. 14, issue 02, 239-264

Abstract: This paper proposes a simple scheme for static hedging of defaultable contingent claims. It generalizes the techniques developed by Carr and Chou (1997), Carr and Madan (1998), and Takahashi and Yamazaki (2009a) to credit-equity models. Our scheme provides a hedging strategy across credit and equity markets, where suitable defaultable contingent claims are accurately replicated by a feasible number of plain vanilla equity options. Another point is that shorter maturity options are available to hedge longer maturity defaultable contingent claims. Through numerical examples, it is shown that the scheme is applicable to both structural and intensity-based models.

Keywords: Static hedging; default risk; equity options; defaultable bonds; structural model; intensity-based model (search for similar items in EconPapers)
Date: 2011
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DOI: 10.1142/S0219024911006383

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