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Static Hedging Of Defaultable Contingent Claims: A Simple Hedging Scheme Across Equity And Credit Markets

Author

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  • SHUICHI OHSAKI

    (Barclays Capital Inc., 6-10-1, Roppongi, Minato-ku, Tokyo 106-6131, Japan)

  • AKIRA YAMAZAKI

    (Graduate School of Economics, University of Tokyo, 7-3-1 Hongo, Bunkyo-ku, Tokyo, 113-0033, Japan;
    Mizuho-DL Financial Technology Co., Ltd., 1-3, Otemachi 1-chome, Chiyoda-ku, Tokyo 100-0004, Japan)

Abstract

This paper proposes a simple scheme for static hedging of defaultable contingent claims. It generalizes the techniques developed by Carr and Chou (1997), Carr and Madan (1998), and Takahashi and Yamazaki (2009a) to credit-equity models. Our scheme provides a hedging strategy across credit and equity markets, where suitable defaultable contingent claims are accurately replicated by a feasible number of plain vanilla equity options. Another point is that shorter maturity options are available to hedge longer maturity defaultable contingent claims. Through numerical examples, it is shown that the scheme is applicable to both structural and intensity-based models.

Suggested Citation

  • Shuichi Ohsaki & Akira Yamazaki, 2011. "Static Hedging Of Defaultable Contingent Claims: A Simple Hedging Scheme Across Equity And Credit Markets," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 14(02), pages 239-264.
    • Handle: RePEc:wsi:ijtafx:v:14:y:2011:i:02:n:s0219024911006383
    DOI: 10.1142/S0219024911006383
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    References listed on IDEAS

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    1. Benjamin Yibin Zhang & Hao Zhou & Haibin Zhu, 2009. "Explaining Credit Default Swap Spreads with the Equity Volatility and Jump Risks of Individual Firms," The Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 5099-5131, December.
    2. Bajlum, Claus & Tind Larsen, Peter, 2007. "Capital Structure Arbitrage: Model Choice and Volatility Calibration," Working Papers 2007-230, Copenhagen Business School, Department of Finance.
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    Cited by:

    1. Akira Yamazaki, 2022. "Recovering subjective probability distributions," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(7), pages 1234-1263, July.

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