Abstract
The canonical valuation, proposed by Stutzer [1996. Journal of Finance 51, 1633–1652], is a nonparametric option pricing approach for valuing European-style contingent claims. This paper derives risk-neutral dynamic hedge formulae for European call and put options under canonical valuation that obey put–call parity. Further, the paper documents the error-metrics of the canonical hedge ratio and analyzes the effectiveness of discrete dynamic hedging in a stochastic volatility environment. The results suggest that the nonparametric hedge formula generates hedges that are substantially unbiased and is capable of producing hedging outcomes that are superior to those produced by Black and Scholes [1973. Journal of Political Economy 81, 637–654] delta hedging.
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