We show that when a derivative portfolio has different correlated underlyings, hedging using classical greeks (first-order derivatives) is not the best possible choice. We first show how to adjust greeks to take correlation into account and reduce P&L volatility. Then we embed correlation-adjusted greeks in a global hedging strategy that reduces cost of hedging without increasing P&L volatility, by optimization of hedge re-adjustments. The strategy is justified in terms of a balance between transaction costs and risk-aversion, but, unlike more complex proposals from previous literature, it is completely defined by observable parameters, geometrically intuitive, and easy to implement for an arbitrary number of risk factors. We test our findings on a CVA hedging example. We first consider daily re-hedging: in this test, correlation-adjusted greeks allow the reduction of P&L volatility by more than 30% compared to standard deltas. Then we apply our general strategy to a context where a CVA portfolio is exposed to both credit and interest rate risk. The strategy keeps P&L volatility in line with daily standard delta-hedging, but with massive cost-saving: only six rebalances of the illiquid credit hedge are performed, over a period of six months.

Daluiso, R., Morini, M. (2017). Hedging efficiently under correlation. QUANTITATIVE FINANCE, 17(10), 1535-1547 [10.1080/14697688.2017.1299201].

Hedging efficiently under correlation

DALUISO, ROBERTO
Primo
;
MORINI, MASSIMO
2017

Abstract

We show that when a derivative portfolio has different correlated underlyings, hedging using classical greeks (first-order derivatives) is not the best possible choice. We first show how to adjust greeks to take correlation into account and reduce P&L volatility. Then we embed correlation-adjusted greeks in a global hedging strategy that reduces cost of hedging without increasing P&L volatility, by optimization of hedge re-adjustments. The strategy is justified in terms of a balance between transaction costs and risk-aversion, but, unlike more complex proposals from previous literature, it is completely defined by observable parameters, geometrically intuitive, and easy to implement for an arbitrary number of risk factors. We test our findings on a CVA hedging example. We first consider daily re-hedging: in this test, correlation-adjusted greeks allow the reduction of P&L volatility by more than 30% compared to standard deltas. Then we apply our general strategy to a context where a CVA portfolio is exposed to both credit and interest rate risk. The strategy keeps P&L volatility in line with daily standard delta-hedging, but with massive cost-saving: only six rebalances of the illiquid credit hedge are performed, over a period of six months.
Articolo in rivista - Articolo scientifico
Correlation; Credit Value Adjustment; CVA; Hedging; Risk-aversion; Transaction costs;
Correlation; Credit Value Adjustment; CVA; Hedging; Risk-aversion; Transaction costs; Finance; Economics, Econometrics and Finance (all)2001 Economics, Econometrics and Finance (miscellaneous)
English
1535
1547
13
Daluiso, R., Morini, M. (2017). Hedging efficiently under correlation. QUANTITATIVE FINANCE, 17(10), 1535-1547 [10.1080/14697688.2017.1299201].
Daluiso, R; Morini, M
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/10281/169246
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