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An empirical analysis of dynamic multiscale hedging using wavelet decomposition

✍ Scribed by Thomas Conlon; John Cotter

Publisher
John Wiley and Sons
Year
2011
Tongue
English
Weight
909 KB
Volume
32
Category
Article
ISSN
0270-7314

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✦ Synopsis

This study 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 scale‐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.

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