This paper extends the classical variance-optimal hedging approach to incorporate Wishart process-driven covariance dynamics for hedging basket and spread options in regime-switching markets. The proposed method achieves a 44.4% reduction in hedging error variance compared to naive delta hedging.
Key findings
Develops a variance-optimal hedging framework incorporating Wishart process-driven covariance dynamics.
Proposes a comprehensive comparison of hedging strategies across calm, stressed, and regime-switching market regimes.
Demonstrates substantial improvements in hedging performance with variance reductions of up to 44% compared to naive strategies.
Analyzes the computational efficiency of different approaches, providing practical guidance for implementation.
Limitations & open questions
Increased accuracy comes at higher computational cost.
Further research needed to explore the scalability of the proposed approach in real-world applications.