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Pricing and Hedging Guaranteed Equity Securities

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  • David Lee

    (BMO)

Abstract

Equity-linked securities with a guaranteed return gain popularity in financial market. The contract depends on the performance of a basket of equity components averaged over a certain period, and also guarantees the investor a minimum return. This paper presents a new method for valuing the guaranteed equity-linked securities. We compute the security's price, corresponding hedge ratios, and risk sensitivities. The model appears to be accurate over a wide range of underlying security parameters, based on numerical studies.

Suggested Citation

  • David Lee, 2023. "Pricing and Hedging Guaranteed Equity Securities," Working Papers hal-04140384, HAL.
    • Handle: RePEc:hal:wpaper:hal-04140384
    Note: View the original document on HAL open archive server: https://hal.science/hal-04140384
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    File URL: https://hal.science/hal-04140384/document
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    References listed on IDEAS

    as
    1. Johnson, Herb & Stulz, Rene, 1987. "The Pricing of Options with Default Risk," Journal of Finance, American Finance Association, vol. 42(2), pages 267-280, June.
    2. Hull, John & White, Alan, 1995. "The impact of default risk on the prices of options and other derivative securities," Journal of Banking & Finance, Elsevier, vol. 19(2), pages 299-322, May.
    3. Klein, Peter, 1996. "Pricing Black-Scholes options with correlated credit risk," Journal of Banking & Finance, Elsevier, vol. 20(7), pages 1211-1229, August.
    4. Klein, Peter & Inglis, Michael, 2001. "Pricing vulnerable European options when the option's payoff can increase the risk of financial distress," Journal of Banking & Finance, Elsevier, vol. 25(5), pages 993-1012, May.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Guaranteed equity security hedge ratio risk sensitivity asset pricing derivative valuation risk management JEL Classification: E44 G21 G12 G24 G32 G33 G18 G28; Guaranteed equity security; hedge ratio; risk sensitivity; asset pricing; derivative valuation; risk management;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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