Downside risk of derivative portfolios with mean-reverting underlyings

Patrick Leoni ()

No 2/2009, Discussion Papers on Economics from University of Southern Denmark, Department of Economics

Abstract: We carry out a Monte-Carlo simulation of a standard portfolio management strategy involving derivatives, to estimate the sensitivity of its downside risk to a change of mean-reversion of the underlyings. We find that the higher the intensity of mean-reversion, the lower the probability of reaching a pre-determined loss level. This phenomenon appears of large statistical significance for large enough loss levels. We also find that the higher the mean-reversion intensity of the underlyings, the longer the expected time to reach those loss levels. The simulations suggest that selecting underlyings with high mean-reversion effect is a natural way to reduce the downside risk of those widely traded assets.

Keywords: Monte Carlo simulation; mean-reverting underlyings (search for similar items in EconPapers)
JEL-codes: C15 G20 (search for similar items in EconPapers)
Pages: 18 pages
Date: 2009-01-02
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Persistent link: https://EconPapers.repec.org/RePEc:hhs:sdueko:2009_002

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