Advances in Risk Management

TARAS BELETSKI AND RALF KORN 189

Table 9.1Corresponding hedging errors

Panel A

σ 21 0.04 0 −0.04

xH 1 H 2 H 1 H 2 H 1 H 2

100 0 16.69 0 16.67 0 16.69

95 15.94 21.91 20.26 26.16 23.79 31.78

90 63.76 71.23 81.06 83.61 95.12 97.42

Panel B

σ 21 0.04 0 −0.04

xH 1 H 2 H 1 H 2 H 1 H 2

100 0 16.04 0 16.01 0 16.04

95 6.16 16.14 9.57 17.22 13.72 19.60

90 24.66 45.42 38.29 54.47 54.88 64.89

from buying inflation-linked products and so there are counterparts to the
risk-averse investors of section 3.

9.5 Conclusion

We have presented a simple modeling framework for pricing and deal-
ing with inflation-linked products. After having derived Black–Scholes-type
pricing formulae in section 9.2, we considered standard portfolio problems
for investing in bond, stocks and inflation-linked products which could be
solved by the martingale method. As a consequence we obtained that typ-
ically risk-averse investors sell standard inflation-linked products (such as
inflation-linked coupon bonds) short. The necessary counterparts for cre-
ating an active market of inflation-linked products are investors that have
to hedge inflation related payments (such as insurance companies), a fact
which is demonstrated in section 9.4.
Future research will be centered around more detailed models including
perhaps stochastic interest rates as in Jarrow andYildirim (2003) or in general
incomplete markets.

REFERENCES

Ang, A. and Bekaert, G. (2003) “The Term Structure of Real Interest Rates and Expected
Inflation”, Working Paper, Columbia University, New York.
Fisher, I. (1930)The Theory of Interest(London/Basingstoke: Macmillan).