PERFORMANCE OF ROBUST HEDGES FOR DIGITAL DOUBLE BARRIER OPTIONS

Jan Obłój () and Frédérik Ulmer ()
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Jan Obłój: Mathematical Institute and Oxford-Man Institute of Quantitative Finance, University of Oxford, 24-29 St Giles, Oxford OX1 3LB, UK

International Journal of Theoretical and Applied Finance (IJTAF), 2012, vol. 15, issue 01, 1-34

Abstract: We analyze the performance of robust hedging strategies of digital double barrier options of Cox and Obłój (2011) against that of traditional hedging methods such as delta and delta/vega hedging. Digital double barrier options are financial derivative contracts which pay out a fixed amount on the condition that the underlying asset remains within or breaks into a range defined by two distinct barrier levels. We perform the analysis in hypothetical forward markets driven by models with stochastic volatility and jumps, calibrated to the AUD/USD foreign exchange rate market. Our findings are strikingly unanimous and suggest that, in the presence of model uncertainty and/or transaction costs, robust hedging strategies typically outperform in a substantial way model-specific hedging methods.

Keywords: Robust hedging; evaluation of hedging strategies; Skorokhod embedding; digital double barrier option (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (8)

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DOI: 10.1142/S0219024911006516

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