Static Hedging of Exotic Options

Authors

  • Peter Carr,

    1. Equity Derivatives Research at Morgan Stanley
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  • Katrina Ellis,

    1. Johnson Graduate School of Management, Cornell University
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  • Vishal Gupta

    1. Goldman Sachs
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    • Carr is a VP in Equity Derivatives Research at Morgan Stanley. Ellis is a graduate student at the Johnson Graduate School of Management, Cornell University. Gupta is at Goldman Sachs; this work was completed while he was an MBA student at the Johnson Graduate School of Management, Cornell University. We are grateful to Warren Bailey, Hal Bierman, Sergio Bien-stock, Phelim Boyle, Linda Canina, Melanie Cao, Narat Charupat, Neil Chriss, Emanuel Derman, Zhenyu Duanmu, Larry Harris, Eric Jacquier, Robert Jarrow, Iraj Kani, Antoine Kotze, James Kuczmarski, Robert Merton, Alan Shapiro, and especially Jonathan Bowie for their comments. We would similarly like to thank participants of presentations at the Fields Institute and at Risk conferences on volatility, equity derivatives, and exotic options. Finally, we thank participants of finance workshops at Cornell University, Goldman Sachs, Harvard University, J.P. Morgan, Morgan Stanley, NationsBank, Salomon Brothers, and the University of Southern California. We also acknowledge the outstanding research assistance of Cem Inal. They are not responsible for any errors.


ABSTRACT

This paper develops static hedges for several exotic options using standard options. The method relies on a relationship between European puts and calls with different strike prices. The analysis allows for constant volatility or for volatility smiles or frowns.

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