Interest rate risk in long-dated commodity options positions: To hedge or not to hedge? |
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Authors: | Benjamin Cheng Christina Sklibosios Nikitopoulos Erik Schlögl |
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Institution: | Finance Discipline Group, UTS Business School, University of Technology Sydney, Broadway, NSW, Australia |
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Abstract: | We empirically assess hedging interest rate risk beyond the conventional delta, gamma, and vega hedges in long-dated crude oil options positions. Using factor hedging in a model featuring stochastic interest rates and stochastic volatility, interest rate hedges consistently provide an improvement beyond delta, gamma, and vega hedges. Under high interest rate volatility and/or when a rolling hedge is used, combining interest rate and delta hedging improves performance by up to four percentage points over the common hedges of gamma and/or vega. Thus, contrary to common practice, hedging interest rate risk should have priority over these “second-order” hedges. |
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Keywords: | delta hedge interest rate hedge long-dated crude oil options stochastic interest rates |
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