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An Empirical Analysis of Dynamic Multiscale Hedging using Wavelet Decomposition

Thomas Conlon and John Cotter ()
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Thomas Conlon: University College Dublin

No 201104, Working Papers from Geary Institute, University College Dublin

Abstract: This paper investigates the hedging effectiveness of a dynamic moving window OLS hedging model, formed using wavelet decomposed time-series. The wavelet transform is applied to calculate the appropriate dynamic minimum-variance hedge ratio for various hedging horizons for a number of assets. The effectiveness of the dynamic multiscale hedging strategy is then tested, both in- and out-of-sample, using standard variance reduction and expanded to include a downside risk metric, the time horizon dependent Value-at-Risk. Measured using variance reduction, the effectiveness converges to one at longer scales, while a measure of VaR reduction indicates a portion of residual risk remains at all scales. Analysis of the hedge portfolio distributions indicate that this unhedged tail risk is related to excess portfolio kurtosis found at all scales.

New Economics Papers: this item is included in nep-rmg
Date: 2011-03-02
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http://www.ucd.ie/geary/static/publications/workingpapers/gearywp201104.pdf First version, 2011 (application/pdf)

Related works:
Journal Article: An empirical analysis of dynamic multiscale hedging using wavelet decomposition (2012)
Working Paper: An Empirical Analysis of Dynamic Multiscale Hedging using Wavelet Decomposition (2011) Downloads
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