Finance Research Letters 2 (2005) 41–50 www.elsevier.com/locate/frl Dynamic, nonparametric hedging of European style contingent claims using canonical valuation Jamie Alcock ∗ , Philip Gray UQ Business School, University of Queensland, St. Lucia 4072, Australia Received 16 August 2004; accepted 8 September 2004 Available online 28 September 2004 Abstract The canonical valuation, proposed by Stutzer [1996. Journal of Finance 51, 1633–1652], is a non- parametric option pricing approach for valuing European-style contingent claims. This paper derives risk-neutral dynamic hedge formulae for European call and put options under canonical valuation that obey put–call parity. Further, the paper documents the error-metrics of the canonical hedge ratio and analyzes the effectiveness of discrete dynamic hedging in a stochastic volatility environment. The results suggest that the nonparametric hedge formula generates hedges that are substantially un- biased and is capable of producing hedging outcomes that are superior to those produced by Black and Scholes [1973. Journal of Political Economy 81, 637–654] delta hedging.  2004 Elsevier Inc. All rights reserved. Keywords: Canonical valuation; Delta hedging; Risk-neutral valuation; Options; Greeks; Put–call parity 1. Introduction Proposed by Stutzer (1996), canonical valuation is a new method for valuing derivative securities under the risk-neutral framework. It is nonparametric, simple to apply and, unlike many alternate nonparametric approaches, does not require any option data. * Corresponding author. E-mail addresses: j.alcock@business.uq.edu.au (J. Alcock), p.gray@business.uq.edu.au (P. Gray). 1544-6123/$ – see front matter  2004 Elsevier Inc. All rights reserved. doi:10.1016/j.frl.2004.09.002