Pricing and hedging power options

In this paper we study the pricing and hedging of options whose payoff is a polynomial function of the underlying price at expiration; so-called ‘power options’. Working in the well-known Black and Scholes (1973) framework we derive closed-form formulas for the prices of general power calls and puts. Parabola options are studied as a special case. Power options can be hedged by statically combining ordinary options in such a way that their payoffs form a piecewise linear function which approximates the power option's payoff. Traditional delta hedging may subsequently be used to reduce any residual risk.     

Pricing and static hedging of European-style double barrier options under the jump to default extended CEV model

This paper develops two novel methodologies for pricing and hedging European-style barrier option contracts under the jump to default extended constant elasticity of variance (JDCEV) model, namely: a stopping time approach based on the first passage time densities of the underlying asset price process through the barrier levels; and a static hedging portfolio approach in which the barrier option is replicated by a portfolio of plain-vanilla and binary options. In doing so, both valuation methodologies are extended to a more general set-up accommodating endogenous bankruptcy, time-dependent barriers and the commonly observed stylized facts of a positive link between default and equity volatility and of a negative link between volatility and stock price. The two proposed numerical methods are shown to be accurate, easy to implement and efficient under both the JDCEV model and the nested constant elasticity of variance model.     

期货市场套期保值线性策略的困境:理论评述

对传统套期保值理论框架中的线性策略进行理论评述,阐述期货市场上存在的非线性特征对传统线性策略所构成的挑战。最后,提出依据连接函数构建非线性套期保值策略的思路。通过案例分析表明,非线性策略能够结合市场不对称相关特征,具备解决市场极端变化以及不对称相关问题的能力。     

Determination of Optimal Hedging Strategy for Index Futures: Evidence from Turkey

This paper aims to determine optimal hedge strategy for the Istanbul Stock Exchange (ISE)-30 stock index futures in Turkey by comparing hedging performance of constant and time-varying hedge ratios under mean-variance utility criteria. We employ standard regression and bivariate GARCH frameworks to estimate constant and time-varying hedge ratios respectively. The Turkish case is particularly challenging since Turkey has one of the most volatile stock markets among emerging economies and the turnover ratio as a measure of liquidity is very high for the market. These facts can be considered to highlight the great risk and, therefore, the extra need for hedging in the Istanbul Stock Exchange (ISE). The empirical results from the study reveal that the dynamic hedge strategy outperforms the static and the traditional strategies.     

Stock Market Mean Reversion and the Optimal Equity Allocation of a Long-Lived Investor

This paper solves numerically the intertemporalconsumption and portfolio choiceproblem of an infinitely-lived investor whofaces a time-varying equity premium.The solutions we obtain are very similarto the approximate analytical solutionsof Campbell and Viceira (1999), except atthe upper extreme of the state spacewhere both the numerical consumption andportfolio rules flatten out.We also consider a constrained version ofthe problem in which the investor facesborrowing and short-sales restrictions.These constraints bind when the equitypremium moves away from its mean in eitherdirection, and are particularly severe forrisk-tolerant investors. The constraints havesubstantial effects on optimalconsumption, but much more modest effects onoptimal portfolio choice in theregion of the state space where they are notbinding.     

Preparing for higher inflation: Portfolio solutions using U.S. equities

Investors have always been interested in reducing inflation risk in their portfolios. However, investors face different types of inflation than those measured by the Consumer Price Index (CPI). Moreover, different asset classes can be used to hedge portfolio inflation. In this paper, we show how individual equities can be used to construct equity portfolios sensitive to customized inflation targets. We illustrate portfolios for three types of inflation: US headline CPI, Forbes Cost of Living Extremely Well Index, and the US Medical Care Price Index. We also show how alternative weighting schemes, such as minimum volatility and maximum inflation beta, can be used to construct inflation‐hedged portfolios.     

An International Asset Pricing Model with Time-Varying Hedging Risk

This paper employs a two-factor international equilibrium asset pricing model to examine the pricing relationships among the world's five largest equity markets. In addition to the traditional market factor premium, a hedging factor premium is included as the second factor to explain the relationship between risks and returns in the international stock markets. Moreover, a GARCH parameterization is adopted to characterize the general dynamics of the conditional second moments. The results suggest that the additional hedging risk premium is needed to explain rates of return on international equities. Furthermore, the restriction that the coefficient on the hedge-portfolio covariance is one smaller than the coefficient on the market-portfolio covariance can not be rejected. This suggests that the intertemporal asset pricing model proposed by Campbell (1993) can be used to explain the returns on the five largest stock market indices.     

Methods of Partial Hedging

In this article we survey methods of dealing with the following problem: A financial agent is trying to hedge a claim C, without having enough initial capital to perform a perfect (super) replication. In particular, we describe results for minimizing the expected loss of hedging the claim C both in complete and incomplete continuous-time financial market models, and for maximizing the probability of perfect hedge in complete markets and markets with partial information. In these cases, the optimal strategy is in the form of a binary option on C, depending on the Radon-Nikodym derivative of the equivalent martingale measure which is optimal for a corresponding dual problem. We also present results on dynamic measures for the risk associated with the liability C, defined as the supremum over different scenarios of the minimal expected loss of hedging C. This revised version was published online in August 2006 with corrections to the Cover Date.     

股指期货套期保值理论及模型的演进与实证研究

将对股指期货套期保值策略进行比较全面的理论和实证研究。首先,概述了股指期货套期保值的相关理论,综述了套期保值的关键环节是最优套期保值比率的确定的相关的模型;其次,运用协整等分析方法,采用最小二乘回归模型（OLS）、向量自回归模型（VAR）、误差修正模型（ECM）、广义自回归条件异方差模型（GARCH）,分别对中国沪深300股指期货最优套期保值比率进行了实证研究,并对各模型的套期保值绩效做出了评价,得出ECM模型是最优的,是最适合中国沪深300股指期货的套期保值率估计模型。     

Corporate Risk Management under Information Asymmetry

This paper examines the financial and operational hedging activities of US pharmaceutical and biotech firms that are subject to a high level of information asymmetry stemming from R&D investments during 2001–2006. We find evidence in support of the information asymmetry hypothesis à la Froot, Scharfstein and Stein (1993) that hedging helps mitigate the under‐investment problem. Specifically, we find that the use of financial derivatives is associated with greater firm value and that the value enhancement is larger for firms subject to greater information asymmetry and better growth opportunities. There is a synergy between financial hedging and operational hedging where the latter is used to counter product development risk. The results are robust with respect to alternative performance measures, industry‐specific growth measures, and the endogeneity problem. Our work is differentiated from existing studies that examined commodity‐based industries without addressing information asymmetry.