Lévy betas: static hedging with index futures

Hoi Ying Wong, Edwin Kwan Hung Cheung, Shiu Fung Wong

Research output: Contribution to journalArticlepeer-review


This study considers calibration to forward-looking betas by extracting information on equity and index options from prices using Lévy models. The resulting calibrated betas are called Lévy betas. The objective of the proposed approach is to capture market expectations for future betas through option prices, as betas estimated from historical data may fail to reflect structural change in the market. By assuming a continuous-time capital asset pricing model (CAPM) with Lévy processes, we derive an analytical solution to index and stock options, thus permitting the betas to be implied from observed option prices. One application of Lévy betas is to construct a static hedging strategy using index futures. Employing Hong Kong equity and index option data from September 16, 2008 to October 15, 2009, we show empirically that the Lévy betas during the sub-prime mortgage crisis period were much more volatile than those during the recovery period. We also find evidence to suggest that the Lévy betas improve static hedging performance relative to historical betas and the forward-looking betas implied by a stochastic volatility model.
Original languageEnglish
Pages (from-to)1034-1059
Number of pages26
JournalThe Journal of Futures Markets
Issue number11
Publication statusPublished - 2012


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