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The trading performance of dynamic hedging models: time varying covariance and volatility transmission effects

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posted on 2008-01-01, 00:00 authored by M T Chng, Gerard Gannon
In this paper, we investigate the value of incorporating implied volatility from related option markets in dynamic hedging. We comprehensively model the volatility of all four S&P 500 cash, futures, index option and futures option markets simultaneously. Synchronous half-hourly observations are sampled from transaction data. Special classes of extended simultaneous volatility systems (ESVL) are estimated and used to generate out-of-sample hedge ratios. In a hypothetical dynamic hedging scheme, ESVLbased hedge ratios, which incorporate incremental information in the implied volatilities of the two S&P 500 option markets, generate profits from interim rebalancing of the futures hedging position that are incremental over competing hedge ratios. In addition, ESVL-based hedge ratios are the only hedge ratios that manage to generate sufficient
profit during the hedging period to cover losses incurred by the physical portfolio .

History

Series

School Working Paper - Accounting/Finance Series

Pagination

1 - 33

Publisher

Deakin University, School of Accounting, Economics and Finance

Place of publication

Geelong, Vic.

Language

eng

Publication classification

CN.1 Other journal article

Copyright notice

2008, The Authors

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