Using Market Greeks to Hedge Non-Standardized Swaption by Standardized Swaption
Date Issued
2016
Date
2016
Author(s)
Wang, Yu-Wen
Abstract
In the past, we use model Greeks, the derivatives of the price with respect to the model parameter, to construct perfectly hedged portfolio. Since the frequency of recalibration is very high, the true risk factor should be market quotes rather than model parameter. Thus, the sensitivities of prices directly with respect to the market quotes, called Market Greeks, seems more important and reasonable. In this paper, we constructed different portfolios consisting of standardized swaption to perfectly hedge a non-standardized swaption. We used the market quotes of the 7 standardized swaptions to calibrate model parameters and evaluate the 4.5Yx5Y Swaption, then computed the model Greeks and market Greeks and also constructed hedged portfolio based on each Greeks. By inspecting the payoff pattern of the hedging portfolio in the following two months, we found that, even in the same evaluating process and with the same model assumptions, market Greeks based is much better than model Greeks based. Findings regarding to the interaction between target swaption and other related swaption are really useful, since they can remarkably reduce the volatility of hedging portfolio. In addition, minimizing total absolute error to calibrate model parameter is better than minimizing total relative error regarding to the difference of calculated swaption price and the volatility of the hedging portfolio. To sum up, we not only practically applied the market Greeks to hedge a non-standardized swaption, but also found out how to choose effective hedging tool from many relative standardized swaption.
Subjects
Calibration
Greeks
Hedge
Market Greeks
Swaption
Type
thesis
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