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Hedging Under Stochastic Volatility

In: Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume II)

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  • K. RONNIE SIRCAR

    (Department of Mathematics, University of Michigan, Ann Arbor, MI 48109-1109, USA)

Abstract

We present a family of hedging strategies for a European derivative security in a stochastic volatility environment. The strategies are robust to specification of the volatility process and do not need a parametric description of it or estimation of the volatility risk premium. They allow the hedger to control the probability of hedging success according to risk aversion. The formula exploits the separation between the time-scale of asset price fluctuation (ticks) and the longer time-scale over which volatility fluctuates, that is, the observed "persistence" of volatility. We run simulations that demonstrate the effectiveness of the strategies over the classical Black-Scholes strategy.

Suggested Citation

  • K. Ronnie Sircar, 2001. "Hedging Under Stochastic Volatility," World Scientific Book Chapters, in: Marco Avellaneda (ed.), Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume II), chapter 5, pages 147-162, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789812810663_0005
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