Suppose we have a stock $X$ at which trades at 100 dollars. We suppose the stock follows a geometric brownian motion. We know that the interest rate is zero and annual volatility is 10 percent. How can we hedge the risk?
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2$\begingroup$ Delta hedging of a vanilla European option on X? $\endgroup$– pincopallinoCommented Apr 9, 2014 at 7:37
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1$\begingroup$ It is not really clear what you are trying to hedge - an option? If yes- which one ? $\endgroup$– ProbilitatorCommented Apr 9, 2014 at 9:17
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$\begingroup$ Please tell us what your are asking. $\endgroup$– Richi WaCommented Apr 14, 2014 at 8:11
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$\begingroup$ There may be an option somewhere.... $\endgroup$– Lucas MorinCommented Jul 9, 2014 at 22:55
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3 Answers
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You sell your stock $S$ against some cash.
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You need a risk model to understand the sources of risk for your stock. If the risk factors can be traded then you can use the factor loadings to hedge your risk.
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$\begingroup$ This is only true if the factor are investable. This is a geometric Brownian motion - this is theoretical only. $\endgroup$– Richi WaCommented Jul 9, 2014 at 8:25
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You first need to define "hedge". Or else the question remains undefined, and the minimum risk is achieved not trading at all ;-)
