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An Empirical Comparison of Option‐Pricing Models in Hedging Exotic Options

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  • Yunbi An
  • Wulin Suo

Abstract

This paper examines the empirical performance of various option‐pricing models in hedging exotic options, such as barrier options and compound options. A practical and relevant testing approach is adopted to capture the essence of model risk in option pricing and hedging. Our results indicate that the exotic feature of the option under consideration has a great impact on the relative performance of different option‐pricing models. In addition, for any given model, the more “exotic” the option, the poorer the hedging effectiveness.

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  • Yunbi An & Wulin Suo, 2009. "An Empirical Comparison of Option‐Pricing Models in Hedging Exotic Options," Financial Management, Financial Management Association International, vol. 38(4), pages 889-914, December.
    • Handle: RePEc:bla:finmgt:v:38:y:2009:i:4:p:889-914
    DOI: 10.1111/j.1755-053X.2009.01060.x
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    2. Harish S. Bhat & Nitesh Kumar, 2015. "Large-Scale Empirical Tests of the Markov Tree Model," IJFS, MDPI, vol. 3(3), pages 1-39, July.
    3. Baule, Rainer & Shkel, David, 2021. "Model risk and model choice in the case of barrier options and bonus certificates," Journal of Banking & Finance, Elsevier, vol. 133(C).
    4. Ryszard Kokoszczyński & Paweł Sakowski & Robert Ślepaczuk, 2017. "Which Option Pricing Model Is the Best? HF Data for Nikkei 225 Index Options," Central European Economic Journal, Sciendo, vol. 4(51), pages 18-39.
    5. Bedendo, Mascia & Campolongo, Francesca & Joossens, Elisabeth & Saita, Francesco, 2010. "Pricing multiasset equity options: How relevant is the dependence function?," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 788-801, April.
    6. Gabriela Pesce & Florencia Verónica Pedroni & Etelvina Chávez & María de la Paz Moral & María Andrea Rivero, 2021. "Exotic options: conceptualization and evolution in the literature from a systematic review," Lecturas de Economía, Universidad de Antioquia, Departamento de Economía, issue 95, pages 231-275, July-Dece.
    7. Leonidas S. Rompolis & Elias Tzavalis, 2017. "Pricing and hedging contingent claims using variance and higher order moment swaps," Quantitative Finance, Taylor & Francis Journals, vol. 17(4), pages 531-550, April.

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