Mean-variance hedging for interest rate models with stochastic volatility

Biagini, Francesca (2002): Mean-variance hedging for interest rate models with stochastic volatility. In: Decisions in Economics and Finance, Vol. 25, No. 1: pp. 1-17

Abstract

The mean-variance hedging approach for pricing and hedging claims in incomplete markets was originally introduced for risky assets. The aim of this paper is to apply this approach to interest rate models in the presence of stochastic volatility, seen as a consequence of incomplete information. We fix a finite number of bonds such that the volatility matrix is invertible and provide an explicit formula for the density of the variance-optimal measure which is independent of the chosen times of maturity.

Finally, we compute the mean-variance hedging strategy for a caplet and compare it with the optimal stategy according to the local risk minimizing approach.

• Item Type: Journal article
• Faculties: Mathematics, Computer Science and Statistics > Mathematics > Workgroup Financial Mathematics
• Subjects: 500 Science > 510 Mathematics
• ISSN: 1593-8883
• Language: English