A Framework for Constructing Equity-Risk-Mitigation Portfolios

Jamil Baz, Josh Davis, Steve Sapra, Normane Gillmann and Jerry Tsai

Financial Analysts Journal, 2020, vol. 76, issue 3, 81-98

Abstract: The key trade-off among equity-risk-mitigation strategies is their expected return versus their ability to diversify equity risk. In particular, the more reliable a strategy’s equity-hedging properties, the lower its expected return, and vice versa. This article proposes a framework for optimal equity-risk-mitigation portfolio construction. In our model, the investor maximizes the portfolio’s unconditional expected return, subject to a constraint on its conditional equity beta. We show that the return to a risk-mitigation portfolio can be decomposed into hedging and return- generating components. We then demonstrate that optimal risk-mitigation portfolios exhibit better return-defensiveness properties relative to the underlying strategies.Disclosure: The authors report no conflicts of interest. Editor’s Note Submitted 17 June 2019Accepted 14 April 2020 by Stephen J. Brown

Date: 2020
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DOI: 10.1080/0015198X.2020.1758502

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