Dynamic, nonparametric hedging of European style contingent claims using canonical valuation [An article from: Finance Research Letters]

This digital document is a journal article from Finance Research Letters, published by Elsevier in 2005. The article is delivered in HTML format and is available in your Amazon.com Media Library immediately after purchase. You can view it with any web browser.

Description:
The canonical valuation, proposed by Stutzer [1996. Journal of Finance 51, 1633-1652], is a nonparametric option pricing approach for valuing European-style contingent claims. This paper derives risk-neutral dynamic hedge formulae for European call and put options under canonical valuation that obey put-call parity. Further, the paper documents the error-metrics of the canonical hedge ratio and analyzes the effectiveness of discrete dynamic hedging in a stochastic volatility environment. The results suggest that the nonparametric hedge formula generates hedges that are substantially unbiased and is capable of producing hedging outcomes that are superior to those produced by Black and Scholes [1973. Journal of Political Economy 81, 637-654] delta hedging.