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Covered Warrant’s Hedging Strategies

Author: XuePu
Tutor: ZhengZhenLong
School: Xiamen University
Course: Financial Engineering
Keywords: transaction cost hedge stochastic volatili
CLC: F830.91
Type: Master's thesis
Year: 2008
Downloads: 113
Quote: 0
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Abstract


After the covered warrants were issued, the issuer had to use various strategies to hedge the risk exposed. However, it’s difficult to use Delta dynamic hedging strategy to hedge because of the existence of transaction cost as well as disability to hedge continuously. Since the covered warrant is option essentially, this paper considers using option replication strategies to hedge the issuer’s risk exposure.As extensions of the Black-Scholes pricing formula, there are many models finding optimal strategies of discretely replicating an option with transaction costs, which are discussed more representative of the three options hedging models: Hayne E. Leland model, Boyle-Vorst model and Whalley-Wilmott model. Using Monte Carlo simulation and VAR method, this paper discussed the relative performance of these models under the constant and stochastic volatility assumptions respectively, and discovered that the relative performance of these models is not only determined by the parameters in the stochastic volatility model(mainly for the volatility of the volatility),but also has a stable relationship with the instartaneous correlation between the stock price and the volatility ,as well as the situation whether the option is in or out of the money. Based on this discovery, the paper proposed that we can use these models together to improve the efficiency of hedging according to the instantaneous correlation between the stock price and the volatility and the extent to which the option is in or out of money.In addition, this paper made an empirical research on WGJTB1 and SCJTB1 by means of discrete hedging strategies and find that using these models together could improve the hedging performance.

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