Managing value-at-risk for a bond using bond put options |
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Authors: | Griselda Deelstra Ahmed Ezzine Dries Heyman Michèle Vanmaele |
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Affiliation: | (1) Department of Mathematics, ISRO and ECARES, Université Libre de Bruxelles, CP 210, 1050 Brussels, Belgium;(2) Department of Financial Economics, Ghent University, Wilsonplein 5D, 9000 Gent, Belgium;(3) Department of Applied Mathematics and Computer Science, Ghent University, Krijgslaan 281, Building S9, 9000 Gent, Belgium |
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Abstract: | This paper studies a strategy that minimizes the Value-at-Risk (VaR) of a position in a zero-coupon bond by buying a percentage of a put option, subject to a fixed budget available for hedging. We elaborate a formula for determining the optimal strike price for this put option in case of a Vasicek stochastic interest rate model. We demonstrate the relevance of searching the optimal strike price, since moving away from the optimum implies a loss, either due to an increased VaR or due to an increased hedging expenditure. In this way, we extend the results of [Ahn, Boudoukh, Richardson, and Whitelaw (1999). Journal of Finance, 54, 359–375] who minimize VaR for a position in a share. In addition, we look at the alternative risk measure Tail Value-at-Risk. |
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Keywords: | Value-at-Risk Bond hedging Vasicek interest rate model |
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