Pricing and Hedging of Discrete Dynamic Guaranteed Funds
We derive a risk-neutral pricing model for discrete dynamic guaranteed funds with geometric Gaussian underlying security price process. We propose a dynamic hedging strategy by adding a gamma factor to the conventional delta. Simulation results demonstrate that, when hedging discretely, the risk-neutral gamma-adjusted-delta strategy outperforms the dynamic delta hedging strategy by reducing the expected hedging error, lowering the hedging error variability, and improving the self-financing possibility. The discrete dynamic delta-only hedging not only causes potential overcharge to clients but also could be costly to the issuers. We show that a naive application of continuous-time hedging formula to a discrete-time hedging setting tends to worsen these possibilities. Copyright The Journal of Risk and Insurance, 2008.
Year of publication: |
2008
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Authors: | Tse, Wai-Man ; Chang, Eric C. ; Li, Leong Kwan ; Mok, Henry M. K. |
Published in: |
Journal of Risk & Insurance. - American Risk and Insurance Association - ARIA, ISSN 0022-4367. - Vol. 75.2008, 1, p. 167-192
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Publisher: |
American Risk and Insurance Association - ARIA |
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