An improved framework for approximating option prices with application to option portfolio hedging.
An improved framework for approximating option prices with application to option portfolio hedging.
As the price of the underlying asset changes over time, delta of the option changes and a gamma hedge is required along with delta hedge to reduce risk. This paper develops an improved framework to compute delta and gamma values with the average of a range of underlying prices rather than at the conventional fixed ‘one point’. We find that models with time-varying volatility price options satisfactorily, and perform remarkably well in combination with the delta and delta-gamma approximations. Significant improvements are achieved for the GARCH model followed by stochastic volatility models. The new approach can ensure significant improvement in modelling option prices leading to better risk-management decision-making
285-296
Mozumder, Sharif
fd0456fe-2db6-4ea2-bdf5-4f7c06761b24
Dempsey, Michael
ac5479d6-1337-4895-94b5-033420a23af2
Humayun Kabir, M.
fd6222cb-4c4a-4c94-b048-8d7c0b0b84d2
Choudhry, Taufiq
6fc3ceb8-8103-4017-b3b5-2d38efa57728
December 2016
Mozumder, Sharif
fd0456fe-2db6-4ea2-bdf5-4f7c06761b24
Dempsey, Michael
ac5479d6-1337-4895-94b5-033420a23af2
Humayun Kabir, M.
fd6222cb-4c4a-4c94-b048-8d7c0b0b84d2
Choudhry, Taufiq
6fc3ceb8-8103-4017-b3b5-2d38efa57728
Mozumder, Sharif, Dempsey, Michael, Humayun Kabir, M. and Choudhry, Taufiq
(2016)
An improved framework for approximating option prices with application to option portfolio hedging.
Economic Modelling, .
(doi:10.1016/j.econmod.2016.07.023).
Abstract
As the price of the underlying asset changes over time, delta of the option changes and a gamma hedge is required along with delta hedge to reduce risk. This paper develops an improved framework to compute delta and gamma values with the average of a range of underlying prices rather than at the conventional fixed ‘one point’. We find that models with time-varying volatility price options satisfactorily, and perform remarkably well in combination with the delta and delta-gamma approximations. Significant improvements are achieved for the GARCH model followed by stochastic volatility models. The new approach can ensure significant improvement in modelling option prices leading to better risk-management decision-making
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Accepted/In Press date: 31 July 2016
e-pub ahead of print date: 13 August 2016
Published date: December 2016
Organisations:
Southampton Business School
Identifiers
Local EPrints ID: 402503
URI: http://eprints.soton.ac.uk/id/eprint/402503
ISSN: 0264-9993
PURE UUID: ea6e789c-3a77-42fe-afa2-532f8554c10c
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Date deposited: 09 Nov 2016 14:26
Last modified: 16 Mar 2024 03:16
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Author:
Sharif Mozumder
Author:
Michael Dempsey
Author:
M. Humayun Kabir
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