Regime-dependent smile-adjusted delta hedging

Alexander, Carol, Rubinov, Alexander, Kalepky, Markus and Leontsinis, Stamatis (2012) Regime-dependent smile-adjusted delta hedging. Journal of Futures Markets, 32 (3). pp. 203-229. ISSN 0270-7314

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Abstract

We introduce several regime-dependent smile-adjusted deltas and compare their efficiency with the smile-adjusted deltas that are popular with option traders. Using years of daily option prices, out-of-sample hedging performance tests for options of all moneyness and maturities and daily, weekly, or fortnightly rebalancing show that even the simplest regime-dependent smile-adjustment consistently outperforms implied BSM delta hedging and local volatility and minimum variance smile-adjustments. Markov-switching deltas offer the best performance, with delta-hedging errors often half the size of implied BSM hedging errors. During volatile markets risk reduction from regime-dependent delta hedging is much greater than during tranquil periods.

Item Type: Article
Schools and Departments: School of Business, Management and Economics > Business and Management
Subjects: H Social Sciences > HG Finance
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Depositing User: Carol Alexander
Date Deposited: 11 Sep 2012 11:21
Last Modified: 11 Sep 2012 11:21
URI: http://sro.sussex.ac.uk/id/eprint/40622
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