LAUSR

This paper is concerned with resolving the empirical unspanned stochastic volatility (USV) question from a hedging point of view. We hedge caps that trade in the Johannesburg swap market, as well as caps simulated from two benchmarks models, which each have a USV and non-USV version. We find that the hedging results are not directly informative vis-a-vis the presence of USV, and using our simulated data, we show that the hedging results found in previous papers are compatible with both USV and non-USV models. We develop a two-tier regression test that isolates hedging errors relating to volatility, and, with substantial support from the simulation experiments, find strong evidence that USV is present in our dataset.