A Comparison of Pricing and Hedging Performances of Equity Derivatives Models
(2018) Applied Economics — Vol. 50, n° 10, p. 1122-1137 (2018)
Files
Applied_Economics_DIAL.pdf
Restricted Access - Adobe PDF
- 539.75 KB
Details
- Authors
- Abstract
- This paper investigates the pricing/hedging conundrum, i.e. the observation of a mismatch between derivatives models' pricing and hedging performances, that has so far been under-emphasized as the literature tends to focus on increasingly complicated option pricing models, without adequately addressing hedging performance. Hence, we analyze the ability of the Black-Scholes, Practitioner Black-Scholes, Heston-Nandi and Heston models to Delta-hedge a set of call options on the S&P500 index and Apple stock. We extend earlier studies in that we consider the impact of asset dynamics, apply a stringent payoff replication strategy, look at the impact of moneyness at maturity and test for the robustness to the parameters’ calibration frequency and Delta-Vega hedging. The study shows that adding risk factors to a model, such as stochastic volatility, should only be considered in light of the data dynamics. Even then, however, more complicated models generally fare poorly for hedging purposes. Hence, a better fit of a model to option prices is not a good indicator of its hedging performance, and so of its ability to describe the underlying dynamics. This can be understood for reasons of over-fitting. Those findings hint to a potentially appealing hedging-based calibration of models' parameters, rather than the standard pricing-based one.
- Affiliations
Citations
Lassance, N., & Vrins, F. (2018). A Comparison of Pricing and Hedging Performances of Equity Derivatives Models. Applied Economics, 50(10), 1122-1137. https://doi.org/10.1080/00036846.2017.1352080 (Original work published 2018)