NDLI: Adapted hedging

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Adapted hedging

Content Provider	Springer Nature Link
Author	Madan, Dilip B.
Copyright Year	2016
Abstract	Exponentials of squared returns in Gaussian densities, with their consequently thin tails, are replaced by the absolute return to form Laplacian and exponentially tilted Laplacian densities at unit time. Scaling provides densities at other maturities. Stochastic processes with these marginals are identified. In addition to a specific local volatility model the densities are consistent with the difference of compound exponential processes taken at log time and scaled by the square root of time. The underlying process has a single parameter, the constant variance rate of the process. Delta hedging using Laplacian and Asymmetric Laplacian implied volatilities are developed and compared with Black Merton Scholes implied volatility hedging.The hedging strategies are implemented for stylized businesses represented by dynamic volatility indexes. The Laplacian hedge is seen to be smoother for the skew trade. It also performs better through the financial crisis for the sale of strangles. The Laplacian and Gaussian models are then synthesized as special cases of a model allowing for other powers between unity and the square. Numerous hedging strategies may be run using different powers and biases in the probability of an up move. Adapted strategies that select the best performer on past quarterly data can dominate fixed strategies. Adapted hedging strategies can effectively reduce drawdowns in the marked to market value of businesses trading options.
Starting Page	305
Ending Page	334
Page Count	30
File Format	PDF
ISSN	16142446
Journal	Annals of Finance
Volume Number	12
Issue Number	3-4
e-ISSN	16142454
Language	English
Publisher	Springer Berlin Heidelberg
Publisher Date	2016-11-09
Publisher Place	Berlin, Heidelberg
Access Restriction	One Nation One Subscription (ONOS)
Subject Keyword	Fat tails Bid prices Non-additive probability Dynamic volatility indices Finance Economic Theory/Quantitative Economics/Mathematical Methods Quantitative Finance Macroeconomics/Monetary Economics//Financial Economics
Content Type	Text
Resource Type	Article
Subject	Finance

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