Discrete Time Hedging of OTC Options in a GARCH Environment: A Simulation Experiment

Gustaf E. Hagerud
Additional contact information
Gustaf E. Hagerud: Department of Finance, Postal: Stockholm School of Economics, Box 6501, 113 83 Stockholm, Sweden

No 165, SSE/EFI Working Paper Series in Economics and Finance from Stockholm School of Economics

Abstract: This paper examines the effect of using Black and Scholes formula for pricing and hedging options in a discrete time heteroskedastic environment. This is done by a simulation procedure where asset returns are generated from a GARCH (1,1)-t model. In the simulation a hypothetical trader writes an option and then delta- hedges his position until the option expires. It is shown that the variance of the returns on the hedged position is considerably higher in a GARCH (1,1) environment than in a homoskedastic environment. The variance of returns depends greatly on the level of kurtosis in the returns process and on the first-order autocorrelation in centered and squared returns.

Keywords: GARCH; option pricing; Black and Scholes formula; Monte Carlo experiment (search for similar items in EconPapers)
JEL-codes: C15 C22 (search for similar items in EconPapers)
Pages: 22 pages
Date: 1997-03
References: Add references at CitEc
Citations:

Downloads: (external link)
http://swopec.hhs.se/hastef/papers/hastef0165.ps (application/postscript)
http://swopec.hhs.se/hastef/papers/hastef0165.ps.zip (application/postscript)
http://swopec.hhs.se/hastef/papers/hastef0165.pdf (application/pdf)
http://swopec.hhs.se/hastef/papers/hastef0165.pdf.zip (application/pdf)

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:hhs:hastef:0165

Access Statistics for this paper

More papers in SSE/EFI Working Paper Series in Economics and Finance from Stockholm School of Economics The Economic Research Institute, Stockholm School of Economics, P.O. Box 6501, 113 83 Stockholm, Sweden. Contact information at EDIRC.
Bibliographic data for series maintained by Helena Lundin ().