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Model misspecification analysis for bond options and Markovian hedging strategies


Bossy, Mireille; Gibson, Rajna; Lhabitant, Francois-Serge; Pistre, Nathalie; Talay, Denis (2007). Model misspecification analysis for bond options and Markovian hedging strategies. Review of Derivatives Research, 9(2):109-135.

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

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

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:National licences > 142-005
Dewey Decimal Classification:330 Economics
Scopus Subject Areas:Social Sciences & Humanities > Finance
Social Sciences & Humanities > Economics, Econometrics and Finance (miscellaneous)
Language:English
Date:12 September 2007
Deposited On:14 Dec 2018 17:48
Last Modified:27 Feb 2024 04:45
Publisher:Springer
ISSN:1380-6645
OA Status:Green
Publisher DOI:https://doi.org/10.1007/s11147-007-9006-6
  • Content: Published Version
  • Language: English
  • Description: Nationallizenz 142-005