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Discretion of Dynamic Position Adjustment in Hedging Strategy

Author

Listed:
  • Hongfeng Peng

    (School of Economics and Management, Wuhan University, China.)

  • Xiaoyu Tan

    (Corresponding author. School of Economics and Management, Wuhan University, China.)

  • Yi Chen

    (School of Economics and Management, Wuhan University, China.)

Abstract

This paper investigates the trade-off between avoiding portfolio risk and increasing transaction costs in dynamic hedging strategy. In dynamic hedging strategy, although adjusting positions frequently can reduce the risk of portfolio, it inevitably leads to outrageous trading cost. Applying the economic value function, this paper quantifies the value of avoided risk and compares it with the corresponding transaction costs. In this way, decisions can be made at each point, that is, investors can determine whether to dynamically adjust their positions or maintain original positions, thus optimizing the hedging strategy. Furthermore, the empirical results confirm that the strategy modified by economic value is more effective than traditional hedging strategy. By analyzing hedging strategies of different position adjustment cycle, it is proved that the efficiency of dynamic hedging strategy can be improved through economic value modified.

Suggested Citation

  • Hongfeng Peng & Xiaoyu Tan & Yi Chen, 2016. "Discretion of Dynamic Position Adjustment in Hedging Strategy," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(2), pages 86-101, June.
    • Handle: RePEc:rjr:romjef:v::y:2016:i:2:p:86-101
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    hedging; economic value; transaction cost;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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