This paper develops a method for option hedging which is consistent with time-varying preferences and probabilities … the spread between implied and objective volatilities. Hedging results reveal that typical hedging techniques for out …-of-the-money S&P500 index options, such as Black-Scholes or historical minimum variance hedging, are inferior to the EPK hedging …

-of-sample hedging errors than competing models. This comparison includes versions of Markov Tree and Black-Scholes models in which … indicates that the Markov Tree model's superior hedging performance is due to its robustness with respect to noise in option …