A profitable modification to global quadratic hedging

Maciej Augustyniak, Frédéric Godin and Clarence Simard

Journal of Economic Dynamics and Control, 2019, vol. 104, issue C, 111-131

Abstract: Recent research has shown that global quadratic hedging, also known as variance-optimal hedging and mean-variance hedging, can significantly reduce the risk of hedging call and put options with long-term maturities (one year or more), such as Long-Term Equity AnticiPation Securities (LEAPS). We propose a modification to global quadratic hedging that is more profitable on average to the hedger without substantially increasing his downside hedging risk, if at all. We prove mathematically that the expected terminal hedging gain of our modified strategy is greater than that of the global quadratic hedging strategy. The performance of our strategy is evaluated under simulated return paths from GARCH, regime-switching and jump-diffusion models, and under empirical S&P 500 return paths.

Keywords: Risk management; Variance-optimal hedging; Mean-variance hedging; Global risk-minimization; LEAPS (search for similar items in EconPapers)
JEL-codes: C22 C61 G32 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:104:y:2019:i:c:p:111-131

DOI: 10.1016/j.jedc.2019.05.008

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