Hedging Futures Options with Stochastic Interest Rates

Benjamin Cheng, Christina Nikitopoulos-Sklibosios (christina.nikitopoulos@uts.edu.au) and Erik Schlogl
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Benjamin Cheng: Finance Discipline Group, UTS Business School, University of Technology Sydney, http://www.uts.edu.au/about/uts-business-school/finance

No 375, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: This paper presents a simulation study of hedging long-dated futures options, in the Rabinovitch (1989) model which assumes correlated dynamics between spot asset prices and interest rates. Under this model and when the maturity of the hedging instruments match the maturity of the option, forward contracts and futures contracts can hedge both the market risk and the interest rate risk of the options positions. When the hedge is rolled forward with shorter maturity hedging instruments, then bond contracts are additionally required to hedge the interest rate risk. This requirement becomes more pronounced for longer maturity contracts and amplifies as the interest rate volatility increases. Factor hedging ratios are also considered, which are suited for multi-dimensional models, and their numerical efficiency is validated.

Keywords: Futures options; Stochastic interest rates; Delta hedging; Interest rate hedging (search for similar items in EconPapers)
JEL-codes: C60 G13 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2016-09-01
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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