Is the gamma risk of options insurable?

Daniel Egli, Peter Blum, Michel Dacorogna and Ulrich A Müller

MPRA Paper from University Library of Munich, Germany

Abstract: In this article we analyze the risk associated with hedging written call options. We introduce a way to isolate the gamma risk from other risk types and present its loss distribution, which has heavy tails. Moving to an insurance point of view, we define a loss ratio that we find to be well behaved with a slightly negative correlation to traditional lines of insurance business, offering diversification opportunities. The tails of the loss distribution are shown to be much fatter than those of the underlying stock returns. We also show that badly estimated volatility, in the Black-Scholes model, leads to considerably biased values for the replicating portfolio. Operational risk is defined as caused by imperfect delta hedging and is found to be limited in today's markets where the autocorrelation of stock returns is small.

Keywords: Option; Insurance; Risk (search for similar items in EconPapers)
JEL-codes: C49 G19 (search for similar items in EconPapers)
Date: 2005-08-24
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:8564

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