When to Hedge Downside Risk?

Christos Giannikos, Hany Guirguis, Andreas Kakolyris and Tin Shan (Michael) Suen ()
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Hany Guirguis: The O’Malley School of Business, Manhattan College, Riverdale, NY 10471, USA
Andreas Kakolyris: School of Accounting and Finance, College of Business and Public Management, Kean University, Union, NJ 07083, USA
Tin Shan (Michael) Suen: School of Accounting and Finance, College of Business and Public Management, Kean University, Union, NJ 07083, USA

Risks, 2024, vol. 12, issue 2, 1-20

Abstract: Hedging downside risk before substantial price corrections is vital for risk management and long-only active equity manager performance. This study proposes a novel methodology for crafting timing signals to hedge sectors’ downside risk. These signals can be integrated into existing strategies simply by purchasing sector index put options. Our methodology generates successful signals for price corrections in 2000 (dot-com bubble) and 2008 (global financial crisis). A key innovation involves utilizing sector correlations. Major price swings within six months are signaled when a sector exhibits high valuation alongside abnormal correlations with others. Utilizing the price-to-earnings ratio for identifying sectors’ high valuations is more beneficial than the bond–stock earnings yield differential. Our signals are also more efficient than those of standard technical analyses.

Keywords: market timing; risk management; risk hedging; equity market crashes; bond–stock earnings yield differential (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2024
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