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Model-free hedge ratios and scale-invariant models
journal contribution
posted on 2023-06-08, 12:22 authored by Carol AlexanderCarol Alexander, Leonardo M NogueiraA price process is scale-invariant if and only if the returns distribution is independent of the price measurement scale. We show that most stochastic processes used for pricing options on financial assets have this property and that many models not previously recognised as scale-invariant are indeed so. We also prove that price hedge ratios for a wide class of contingent claims under a wide class of pricing models are model-free. In particular, previous results on model-free price hedge ratios of vanilla options based on scale-invariant models are extended to any contingent claim with homogeneous pay-off, including complex, path-dependent options. However, model-free hedge ratios only have the minimum variance property in scale-invariant stochastic volatility models when price–volatility correlation is zero. In other stochastic volatility models and in scale-invariant local volatility models, model-free hedge ratios are not minimum variance ratios and our empirical results demonstrate that they are less efficient than minimum variance hedge ratios.
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Publication status
- Published
Journal
Journal of Banking and FinanceISSN
0378-4266Publisher
ElsevierExternal DOI
Issue
6Volume
31Page range
1839-1861Department affiliated with
- Business and Management Publications
Full text available
- No
Peer reviewed?
- Yes
Legacy Posted Date
2012-09-11Usage metrics
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