A New Scheme for Static Hedging of European Derivatives under Stochastic Volatility Models ( Revised in June 2008, Published in "Journal of Futures Markets", Vol.29-5, 397-413, 2009. )

Abstract

This paper proposes a new scheme for static hedging of European path-independent derivatives under stochastic volatility models.First, we show that pricing European path-independent derivatives under stochastic volatility models is transformed to pricing those under one-factor local volatility models.Next, applying an efficient static replication method for one-dimensional price processes developed by Takahashi and Yamazaki[2007], we present a static hedging scheme for European path-independent derivatives.Finally, a numerical example comparing our method with a dynamic hedging method under the Heston[1993]’s stochastic volatility model is used to demonstrate that our hedging scheme is effective in practice.