Abstract
In this paper, we analyse the model misspecification risk of Markovian hedging strategies for discount bond options. We show how to decompose the Profit and Loss that results from model misspecification, and emphasize the importance of the position’s gamma in order to control it. We further provide mathematical results on the distribution of the forward Profit and Loss function for specific univariate term structure models. Finally, we run numerical simulations for options’ hedging strategies in order to examine the sensitivity of the forward Profit and Loss function with respect to the volatility of the forward rate curve, the frequency of the position rebalancing and the characteristics of the position being hedged.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callSimilar Papers
More From: Review of Derivatives Research
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
