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What is Vega Hedging

What is Vega Hedging?

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Vega hedging: The prices and hedging strategies is only as superior as the model for the underlying. The key parameter which determines the value of a contract is the volatility of the underlying asset. Unluckily, this is a very complicated parameter to measure. Nor is this usually a constant as assumed in the straightforward theories. Clearly, the value of a contract depends upon this parameter, and so to make sure that a portfolio value is insensitive to such parameter we can vega hedge. It implies, we hedge one alternative with both the underlying and another option in such a way which both the delta and the vega, the sensitivity of the portfolio value to volatility, are zero. It is frequently quite satisfactory in practice but is generally theoretically inconsistent; we must not use a constant volatility (fundamental Black–Scholes) model to compute sensitivities to parameters which are assumed not to vary.

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