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arXiv · 1103.4943

An Empirical Analysis of Dynamic Multiscale Hedging using Wavelet Decomposition

Thomas Conlon·John Cotter
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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.

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Thomas Conlon, John Cotter. 2011-03-25. An Empirical Analysis of Dynamic Multiscale Hedging using Wavelet Decomposition. https://arxiv.org/abs/1103.4943

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