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Managing value-at-risk for a bond using bond put options

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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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References

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Authors and Affiliations

  1. Department of Mathematics, ISRO and ECARES, Université Libre de Bruxelles, CP 210, 1050, Brussels, Belgium

    Griselda Deelstra & Ahmed Ezzine

  2. Department of Financial Economics, Ghent University, Wilsonplein 5D, 9000, Gent, Belgium

    Dries Heyman

  3. Department of Applied Mathematics and Computer Science, Ghent University, Krijgslaan 281, Building S9, 9000, Gent, Belgium

    Michèle Vanmaele

Authors
  1. Griselda Deelstra
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  2. Ahmed Ezzine
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  3. Dries Heyman
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  4. Michèle Vanmaele
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Correspondence to Griselda Deelstra.

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Deelstra, G., Ezzine, A., Heyman, D. et al. Managing value-at-risk for a bond using bond put options. Comput Econ 29, 139–149 (2007). https://doi.org/10.1007/s10614-006-9068-9

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  • DOI: https://doi.org/10.1007/s10614-006-9068-9

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