Anybody fiddling with EOM now?

[narwhal]

For task 1,

Did anyone else construct their hedging error calculations using the methodology shown in Hardy, table 8.7 and surrounding discussion?

I constructed a spreadsheet that produced exactly the same values as she shows in table 8.7, and then just changed the parameters to get going on my assignment.

The one thing that makes me hesitant about this approach is the phrase from the exercise: "Regardless of which model is used for the portfolio, the hedge costs are evaluated using the lognormal model and Black-Scholes formula."

In the book, they say "the stock prices in the second column are calculating an accumulation factor each month from a regime-switching lognormal (RSLN) distribution. This is the real-world measure, not the Q-measure, because we are interested in the real-world outcome. The Q-measure is only used for pricing and constructing the hedge portfolio."

So now I'm not sure that my (Hardy's) approach determines hedge costs using the lognormal model. My formulas are a little different than the ones in the exercise in the module, but I thought that the book was a better starting point because there's no mortality, and there's a 2-year maturity date.

But my numbers aren't matching the numbers I was seeing in earlier posts. Could it be that the underlying numbers have changed and I am on the right track?

[Laurelinda]

Hi narwhal, 2 things:
1.) Have you substituted your own scenario accumulation factors (from the RSLN or LN scenarios provided)?
2.) Did you remember the management charge between Ft- and Ft+? (Hardy has no management charge in the table that I can see.)

[narwhal]

thanks for the suggestions

I did use my own accumulation factors, applied to a beginning value of 1,000 rather than 100.

I did incorporate the management charge - the formulas on the bottom of page 145 of Hardy involve the number .97, which is just 1 - the management charge.

I'm just going to go with it, and if I've made a calculation error I'll hope my verbiage is sufficient to outweigh that fact.