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| Author: | Bossaerts, P. Hillon, P. |
| Title: | Local parametric analysis of hedging in discrete time |
| Journal: | Journal of Econometrics
1997 : NOV, Vol. 81:1, p. 243-272 |
| Index terms: | DERIVATIVE SECURITIES VOLATILITY HEDGING |
| Language: | eng |
| Abstract: | When continuous-time portfolio weights are applied to a discrete-time hedging problem, errors are likely to occur. This paper evaluates the overall importance of the discretization-induced tracking error. It does so by comparing the performance of Black-Scholes hedge ratios against those obtained from a novel estimation procedure, namely local parametric estimation. In the latter, the weights of the duplicating portfolio are estimated by fitting parametric models in the neighborhood of the derivative's moneyness and maturity. Local parametric estimation directly incorporates the error from hedging in discrete time. Results are shown where the root mean square tracking error is reduced up to 41% for short-maturity options. |
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