On the Measurement of Hedging Effectiveness for Long-Term Investment Guarantees

Maciej Augustyniak (), Alexandru Badescu and Mathieu Boudreault
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Maciej Augustyniak: Département de Mathématiques et de Statistique, Université de Montréal, P.O. Box 6128, Station Centre-Ville, Montreal, QC H3C 3J7, Canada
Alexandru Badescu: Department of Mathematics and Statistics, University of Calgary, 2500 University Drive NW, Calgary, AB T2N 1N4, Canada
Mathieu Boudreault: Quantact Actuarial and Financial Mathematics Laboratory, Centre de Recherches Mathématiques, Université de Montréal, P.O. Box 6128, Station Centre-Ville, Montreal, QC H3C 3J7, Canada

JRFM, 2023, vol. 16, issue 2, 1-18

Abstract: Although the finance literature has devoted a lot of research into the development of advanced models for improving the pricing and hedging performance, there has been much less emphasis on approaches to measure dynamic hedging effectiveness. This article discusses a statistical framework based on regression analysis to measure the effectiveness of dynamic hedges for long-term investment guarantees. The importance of taking model risk into account is emphasized. The difficulties in reducing hedging risk to an appropriately low level lead us to propose a new perspective on hedging, and recognize it as a tool to modify the risk–reward relationship of the unhedged position.

Keywords: hedging effectiveness; dynamic hedging; model risk; investment guarantee; variable annuity (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2023
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