a hedging problem, which parameter to hedge

MarkChan · August 8th, 2009, 8:21 am

For example, I long an European option and want to hedge it from the beginning. I use the black scholes model to hedge and buy delta underlying, using the implied volatility at t=0. At t=1, I need to rebalance my portfolio and need to update my delta. Which implied volatility I should use, the implied volatility at t=0, or t=1?

accelas · August 8th, 2009, 6:34 pm

you use the one at t=1.at t=0, you used delta at t=0 to hedge. if at t=1 you still use delta at t=0 to hedge, you're not really rebalanced.

MarkChan · August 10th, 2009, 1:42 am

I mean which volatility I should use, since the delta is a function of implied volatility. Should I use the running implied volatility?

untwigged · August 10th, 2009, 11:02 am

See this paper for an explanation on how the chosen volatility affects the portfolio.