The question paraphrased: an investor invested in govs & MBS expects interest rate volatilty to rise significantly and a parallel shift down in interest rates with greater confidence in the vol expectation. The investor also think the OAS on the MBS is attractive. She decides to hedge the MBS interest rate in order to isolate the OAS. Pick if she should use dynamic hedging or options hedging given the vol and interest rate expectations and confidence in those.
Answer paraphrased:
Expected vol > implied vol, so use options hedging. If vol increases, value of options increase
Dynamic hedging not good here b/c would not benefit from increase in option value. In dynamic hedging buy futures after rates declined, sell after rates risen.
My q’s:
1. is implied vol< expected vol in this q. b/c the oas spread is “attractive” and that implies a lower value for the option and therefore lower vol v. the investor’s expectations?
2. Is dynamic hedging not appropriate because you are adjusting your position after vol has been priced in? ie is this a timing issue?
3. Where is the l. 3 curriculum is dynamic hedging v. options hedging discussed? have done a search and looked through index and don’t see it.
Answer paraphrased:
Expected vol > implied vol, so use options hedging. If vol increases, value of options increase
Dynamic hedging not good here b/c would not benefit from increase in option value. In dynamic hedging buy futures after rates declined, sell after rates risen.
My q’s:
1. is implied vol< expected vol in this q. b/c the oas spread is “attractive” and that implies a lower value for the option and therefore lower vol v. the investor’s expectations?
2. Is dynamic hedging not appropriate because you are adjusting your position after vol has been priced in? ie is this a timing issue?
3. Where is the l. 3 curriculum is dynamic hedging v. options hedging discussed? have done a search and looked through index and don’t see it.