We concluded that you cannot rely on delta hedging alone. It sounds simplistic to say that now, but back then, this was the sort of thing people were only just beginning to realize.
More Quotes from John Hull:
One important measurement issue concerns the fat tails problem that I mentioned earlier. VAR is concerned with extreme outcomes. If the tails of the probability distributions we are using are too thin, our VAR measures are likely to be too low.John Hull
Alan White and I spent the next two or three years working together on this. We developed what is known a stochastic volatility model. This is a model where the volatility as well as the underlying asset price moves around in an unpredictable way.
John Hull
Yes, our tree has an interesting shape. The center branches reflect the shape of the zero curve. When extreme parts of the tree are reached the branching pattern changes to accommodate the mean reversion.
John Hull
Briefly speaking, our conclusion is that stochastic volatility does not make a huge difference as far as the pricing is concerned if you get the average volatility right. It makes a big difference as far as hedging is concerned.
John Hull
The HoLee model was the first term structure model. I remember reading their paper soon after it was published and as it was fairly different from many of the other papers that I had read, I had to read it quite a few times. I realized that it was a really important paper.
John Hull
Our research led on to other things, such as the fact that exchange rates are not lognormally distributed.
John Hull
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