21. Dynamic Hedging and Average Life

Financial Theory (ECON 251)

This lecture reviews the intuition from the previous class, where the idea of dynamic hedging was introduced. We learn why the crucial idea of dynamic hedging is marking to market: even when there are millions of possible scenarios that could come to pass over time, by hedging a little bit each step of the way, the number of possibilities becomes much more manageable. We conclude the discussion of hedging by introducing a measure for the average life of a bond, and show how traders use this to figure out the appropriate hedge against interest rate movements.

00:00 - Chapter 1. Review of Dynamic Hedging
09:15 - Chapter 2. Dynamic Hedging as Marking-to-Market
19:55 - Chapter 3. Dynamic Hedging and Prepayment Models in the Market
30:50 - Chapter 4. Appropriate Hedges against Interest Rate Movements
01:05:15 - Chapter 5. Measuring the Average Life of a Bond

Complete course materials are available at the Open Yale Courses website: http://open.yale.edu/courses

This course was recorded in Fall 2009.