Quadratic hedging schemes for non-Gaussian GARCH models
Journal
Journal of Economic Dynamics and Control
ISSN
0165-1889
Type
journal article
Date Issued
2014
Author(s)
Badescu, Alexandru
;
Elliott, Robert J.
;
Ortega, Juan-Pablo
Abstract
We propose different schemes for option hedging when asset returns are modeled using a general class of GARCH models. More specifically, we implement local risk minimization and a minimum variance hedge approximation based on an extended Girsanov principle that generalizes Duan's delta hedge. Since the minimal martingale measure fails to produce a probability measure in this setting, we construct local risk minimization hedging strategies with respect to a pricing kernel. These approaches are investigated in the context of non-Gaussian driven models. Furthermore, we analyze these methods for non-Gaussian GARCH diffusion limit processes and link them to the corresponding discrete time counterparts. A detailed numerical analysis based on S\&P 500 European call options is provided to assess the empirical performance of the proposed schemes. We also test the sensitivity of the hedging strategies with respect to the risk neutral measure used by recomputing some of our results with an exponential affine pricing kernel.
Language
English
Keywords
GARCH models
local risk minimization
martingale measure
bivariate diffusion limit
minimum variance hedge.
HSG Profile Area
SEPS - Quantitative Economic Methods
Refereed
Yes
Publisher
North Holland
Volume
42
Start page
13
End page
32
Eprints ID
249391
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BEO_JEDC84071_final_version.pdf
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