Explain different types of hedge

Question

Explain different types of hedge.

Answer 1

To understand why one might hedge this is helpful to look at the various types of hedging.
The two main probably classifications the most significant distinction between kinds of hedging is among model-independent and model-dependent hedging strategies.

• Model-independent hedging: There is a simple relationship among calls and puts on an asset (while they are both European and with similar strikes and expiries), the underlying stock and a zero-coupon bond along with similar maturity.

This relationship is fully independent of how the underlying asset changes into value. Another illustration is spot-forward parity. Within neither case do we have to identify the dynamics of the asset not even its volatility, to get a possible hedge. That model-independent hedges are, few and far among.

• Model-dependent hedging: mainly sophisticated finance hedging strategies depend upon a model for the underlying asset. The clear example is the hedging utilized in the Black–Scholes analysis which leads to a complete theory for the value of derivatives. Within pricing derivatives we typically required to at least know the volatility of the underlying asset. When the model is wrong then any hedging strategy and the option value could also be wrong.