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Does hedging with implied volatility factors improve the hedging efficiency of barrier options?

Matthias Fengler, Szymon Borak & Wolfgang K. Härdle

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abstract The price of a barrier option depends on the shape of the entire implied volatility surface which is a high-dimensional dynamic object. Barrier options are hence exposed to non-trivial volatility risk. We extract the key risk factors of implied volatility surface fluctuations by means of a semiparametric factor model. Based on the factors we define a practical hedging procedure within a local volatility framework. The hedging performance is evaluated using DAX index options.
   
type journal paper
   
keywords vega hedging
   
language English
kind of paper journal article
date of appearance 1-4-2009
journal The Journal of Risk Model Validation
publisher Incisive Media
ISSN 1753-9579
volume of journal 3
number of issue 1
page(s) 73-92
review double-blind review
   
citation Fengler, M., Borak, S., & Härdle, W. K. (2009). Does hedging with implied volatility factors improve the hedging efficiency of barrier options?. The Journal of Risk Model Validation, 3(1), 73-92.