Managing the Volatility Risk Ofportfolios of Derivative Securities : the Lagrangian Uncertain Volatility

  title={Managing the Volatility Risk Ofportfolios of Derivative Securities : the Lagrangian Uncertain Volatility},
  author={MODELbyMarco and Avellaneda},
We present an algorithm for hedging option portfolios and custom-tailored derivative securities which uses options to manage volatility risk. The algorithm uses a volatility band to model heteroskedasticity and a non-linear partial diierential equation to evaluate worst-case volatility scenarios for any given forward liability structure. This equation gives sub-additive portfolio prices and hence provides a natural ordering of preferences in terms of hedging with options. The second element of… CONTINUE READING
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