Robust Hedging Performance and Volatility Risk in Option Markets

We investigate daily robust hedging performance with trading costs for markets of S&P 500 Index option (SPX) and Taiwan Index option (TXO). Robust hedging refers to minimal model dependence on the risky asset price. Two hedging categories including " model-free " and " volatility-model-free, " and nonparametric methods for volatility estimation are considered in our empirical study. In particular, the instantaneous volatility is estimated by a proposed nonlinear correction scheme of Fourier transform method, justified by a simulation study for a local volatility model. An asymmetric phenomenon of hedging performances is documented. Hedging portfolios constructed from the " volatility-model-free " category induce much higher Sharpe ratios than those from the " model-free " category on SPX, while they perform comparably on TXO. Motivated from the price limit regulation in Taiwan, we further develop a timescale change method to explain this phenomenon. Asymptotic moment estimates of differences of some hedging portfolios are consistent with our empirical findings.