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Implications for hedging of the choice of driving process for one-factor Markov-functional models
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Kennedy, J. E. and Pham, Duy (2013) Implications for hedging of the choice of driving process for one-factor Markov-functional models. International Journal of Theoretical and Applied Finance, Volume 16 (Number 5). Article number 1350030. doi:10.1142/S0219024913500301 ISSN 0219-0249.
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Official URL: http://dx.doi.org/10.1142/S0219024913500301
Abstract
In this paper, we study the implications for hedging Bermudan swaptions of the choice of the instantaneous volatility for the driving Markov process of the one-dimensional swap Markov-functional model. We find that there is a strong evidence in favor of what we term parametrization by time as opposed to parametrization by expiry. We further propose a new parametrization by time for the driving process which takes as inputs into the model the market correlations of relevant swap rates. We show that the new driving process enables a very effective vega-delta hedge with a much more stable gamma profile for the hedging portfolio compared with the existing ones.
Item Type: | Journal Article | ||||
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Divisions: | Faculty of Science, Engineering and Medicine > Science > Statistics | ||||
Journal or Publication Title: | International Journal of Theoretical and Applied Finance | ||||
Publisher: | World Scientific Publishing Co. Pte. Ltd. | ||||
ISSN: | 0219-0249 | ||||
Official Date: | 23 July 2013 | ||||
Dates: |
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Volume: | Volume 16 | ||||
Number: | Number 5 | ||||
Number of Pages: | 51 | ||||
Article Number: | Article number 1350030 | ||||
DOI: | 10.1142/S0219024913500301 | ||||
Status: | Peer Reviewed | ||||
Publication Status: | Published | ||||
Access rights to Published version: | Restricted or Subscription Access |
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