Should Market Makers Hedge with Realised or Implied Volatility?

Alexis Levendis, Pierre Venter () and Eben Maré
Additional contact information
Alexis Levendis: University of Johannesburg
Pierre Venter: University of Johannesburg
Eben Maré: University of Pretoria

A chapter in Advances in Longitudinal Data Methods in Applied Economic Research, 2021, pp 421-430 from Springer

Abstract: Abstract A major challenge faced by market makers is the hedging of contingent liabilities. Option sellers often hedge contingent claims in the classical Black–Scholes framework. Standard theory suggests that the value of an option can be replicated exactly by rebalancing a portfolio of shares and cash continuously. This is referred to as delta-hedging. In the Black–Scholes framework, an explicit solution is available to calculate delta. Market participants agree on most inputs in this formula. Volatility, however, remains an elusive parameter. This leads to the question: Should market makers hedge their liabilities using realised or implied volatility? In this paper, we show that a market maker should choose to hedge their portfolio with implied volatility, since this is less risky than hedging with realised volatility.

Keywords: Black–Scholes; Realised volatility; Implied volatility; Volatility skew; Delta-hedging (search for similar items in EconPapers)
Date: 2021
References: Add references at CitEc
Citations:

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:prbchp:978-3-030-63970-9_29

Ordering information: This item can be ordered from
http://www.springer.com/9783030639709

DOI: 10.1007/978-3-030-63970-9_29

Access Statistics for this chapter

More chapters in Springer Proceedings in Business and Economics from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().