New answers tagged hedging
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On page 119 in Björk (3rd edition) we have the replicating portfolio (equations 8.20 and 8.21): Hold $\frac{\partial C}{\partial s}$ of the stock and $\frac{X_{t}-S_{t}\frac{\partial C}{\partial s}}{B_{t}}$ in the bank-account. The dynamics of this portfolio is given by
$$
dX_{t}=\frac{\partial C}{\partial s}dS_{t}+\frac{X_{t}-S_{t}\frac{\partial C}{\partial ...
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how does one actually go about hedging?
Your OAS model determines your hedging instruments, hedge ratios, and hedging (model) risk. If your OAS model calibrates to the LIBOR swap curve and swaption vols (which is common), then you can generate hedge ratios by computing key rate durations of the underlying swap and swaption instruments.
For example:
Hedging ...
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"Essentially a positive OAS implies that once hedged against the forward LIBOR rates, a security will have positive returns": I don't believe this statement is correct. Essentially, the OAS is a statement about expected excess returns (after hedging out duration and volatility risk as described in the comments above) and says little to nothing ...
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Simple example: euro based investor wants to buy a USTreasury, currency hedged back into Euro. Investor executes the following 2 trades at t=0:
purchase Treasuries for next day settle. Assume usd12mm purchase price.
execute fx swap with cashflows at t=0 : receive usd12mm/pay €10mm and cashflow at t=1yr : pay usd12.0mm/ Rec €9.9mm. (I used spot =1.20 and ...
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Good question!
I think there's some semantics to be thought about first:
The word Hedging commonly implies that you want to hedge the changes in the present value of your total position ($\Pi=PV(A) +wPV(B)$), with $w$ the hedging weight. This statement can be understood locally:
I want to hedge ('immunize') my portfolio to local changes in the **underlying**
...
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As correctly pointed out in the comments, this is due to "timestamp" differences. The future "settlement price" (the official closing price) is set at 5.45pm UK time. The future still trades but the historical price is taken at 5.45. If you look at historical prices in Bloomberg for ZWP1 they are from 5.45pm UK time. However the index (...
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