Article1990

The Systematic Risk of Discretely Rebalanced Option Hedges

19 citations0/0 files storedJournal of Financial and Quantitative Analysis

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Stochastic processes and financial applications Financial Markets and Investment Strategies Financial Risk and Volatility Modeling

Abstract

This paper demonstrates that Black-Scholes option pricing model hedge positions that are risk free when rebalanced continuously will frequently exhibit substantial systematic risk when rebalanced at finite intervals. This systematic risk may have biased important empirical tests of the option pricing model. Moreover, this systematic risk means that the Black-Scholes option pricing model is inherently inconsistent with the discrete time version of the Capital Asset Pricing Model (CAPM).

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1973The Pricing of Options and Corporate Liabilities 1976The Valuation of Uncertain Income Streams and the Pricing of Options 1976The option pricing model and the risk factor of stock 1985Option Pricing and Replication with Transactions Costs 1979The Pricing of Contingent Claims in Discrete Time Models 1982Valuation of American call options on dividend-paying stocks 1980Trading costs for listed options 1980Discretely adjusted option hedges

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2006Small transaction cost asymptotics and dynamic hedging 1998A Portfolio Approach to Risk Reduction in Discretely Rebalanced Option Hedges

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