An Empirical Comparison of Two Stochastic Volatility Models using Indian Market Data
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We conduct an empirical comparison of hedging strategies for two different stochastic volatility models proposed in the literature. One is an asymptotic expansion approach and the other is the risk-minimizing approach applied to a Markov-switched geometric Brownian motion. We also compare these with the Black–Scholes delta hedging strategies using historical and implied volatilities. The derivatives we consider are European call options on the NIFTY index of the Indian National Stock Exchange. We compare a few cases with profit and loss data from a trading desk. We find that for the cases that we analyzed, by far the better results are obtained for the Markov-switched geometric Brownian motion.
KeywordsOption pricing Stochastic volatility Mean reverting Regime switching Risk minimizing
JEL ClassificationC02 C90 G13
We wish to thank Kotak Securities for providing us with options traded data for this paper. We also wish to acknowledge Abhinav Srivastava for some of the preliminary computations done during his summer project. Thanks to the referee for several useful suggestions for improvements to this paper.
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