Lecture 20 - Dynamic Hedging

author: John Geanakoplos, Yale University
recorded by: Yale University
published: March 17, 2012,   recorded: December 2009,   views: 2979
released under terms of: Creative Commons Attribution No Derivatives (CC-BY-ND)
Categories

See Also:

Download Video - generic video source Download yalemecon251f09_geanakoplos_lec20_01.mp4 (Video - generic video source 837.8 MB)

Download Video Download yalemecon251f09_geanakoplos_lec20_01.flv (Video 362.3 MB)

Download Video Download yalemecon251f09_geanakoplos_lec20_01.wmv (Video 322.5 MB)

Download subtitles Download subtitles: TT/XML, RT, SRT


Help icon Streaming Video Help

Related Open Educational Resources

Related content

Report a problem or upload files

If you have found a problem with this lecture or would like to send us extra material, articles, exercises, etc., please use our ticket system to describe your request and upload the data.
Enter your e-mail into the 'Cc' field, and we will keep you updated with your request's status.
Lecture popularity: You need to login to cast your vote.
  Bibliography

Description

Suppose you have a perfect model of contingent mortgage prepayments, like the one built in the previous lecture. You are willing to bet on your prepayment forecasts, but not on which way interest rates will move. Hedging lets you mitigate the extra risk, so that you only have to rely on being right about what you know. The trouble with hedging is that there are so many things that can happen over the 30-year life of a mortgage. Even if interest rates can do only two things each year, in 30 years there are over a billion interest rate scenarios. It would seem impossible to hedge against so many contingencies. The principle of dynamic hedging shows that it is enough to hedge yourself against the two things that can happen next year (which is far less onerous), provided that each following year you adjust the hedge to protect against what might occur one year after that. To illustrate the issue we reconsider the World Series problem from a previous lecture. Suppose you know the Yankees have a 60% chance of beating the Dodgers in each game and that you can bet any amount at 60:40 odds on individual games with other bookies. A naive fan is willing to bet on the Dodgers winning the whole Series at even odds. You have a 71% chance of winning a bet against the fan, but bad luck can cause you to lose anyway. What bets on individual games should you make with the bookies to lock in your expected profit from betting against the fan on the whole Series?

Link this page

Would you like to put a link to this lecture on your homepage?
Go ahead! Copy the HTML snippet !

Write your own review or comment:

make sure you have javascript enabled or clear this field: