NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

NBER Working Papers by Joshua Rosenberg

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Working Papers

December 1994Hedging Options in a GARCH Environment: Testing the Term Structure of Stochastic Volatility Models
with Robert F. Engle: w4958
This paper develops a methodology for testing the term structure of volatility forecasts derived from stochastic volatility models, and implements it to analyze models of S&P 500 index volatility. Volatility models are compared by their ability to hedge options positions sensitive to the term structure of volatility. Overall, the most effective hedge is a Black-Scholes (BS) delta-gamma hedge, while the BS delta-vega hedge is the least effective. The most successful volatility hedge is GARCH components delta-gamma, suggesting that the GARCH components estimate of the term structure of volatility is most accurate. The success of the BS delta-gamma hedge may be due to mispricing in the options market over the sample period.

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