An Examination of the Effects of Parameter Misspecification

Arbeitspapier

It is well-known that Gaussian hedging strategies are robust in the sense that they always lead to a cost process of bounded variation and that a superhedge is possible if upper bounds on the volatility of the relevant processes are available, cf. El Karoui, Jeanblanc-Picque and Shreve (1998) and in particular for applications to fixed income derivatives Dudenhausen, Schlögl and Schlögl (1998). These results crucially depend on the choice of certain ``natural'' hedge instruments which are not always available in the market and fail to hold otherwise. In this paper, the problem of optimally selecting hedging instruments from a given set of traded assets, in particular of zero coupon bonds, is studied. Misspecified hedging strategies lead to a non-vanishing cost process, which in turn depends on the particular choice of instruments. The effect of this choice on the cost process is analyzed. Referring to bond markets, a thorough study of the implications of volatility mismatching is made and explicit results are stated for a broad range of volatility scenarios.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Bonn Econ Discussion Papers ; No. 22/2002

Classification and Topics

• Classification: Wirtschaft ; Contingent Pricing; Futures Pricing; option pricing ; Asset Pricing; Trading Volume; Bond Interest Rates ; Interest Rates: Determination, Term Structure, and Effects
• Subject: Model misspecification ; duplication of bonds ; volatility mismatch ; optimal selection of hedging instruments ; Optionspreistheorie ; Hedging ; Strategie ; Modell-Spezifikation ; Theorie

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Dudenhausen, Antje ; Schlögl, Lutz
• Event: Veröffentlichung
• (who): University of Bonn, Bonn Graduate School of Economics (BGSE)
• (where): Bonn
• (when): 2002

Further information

• Handle: http://hdl.handle.net/10419/22843
• Last update: 10.03.2025, 11:44 AM CET