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An empirical analysis of dynamic multiscale hedging using wavelet decomposition

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  • Thomas Conlon
  • John Cotter

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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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Futures Markets.

Volume (Year): 32 (2012)
Issue (Month): 3 (03)
Pages: 272-299

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Handle: RePEc:wly:jfutmk:v:32:y:2012:i:3:p:272-299

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Cited by:
  1. Thomas Conlon & John Cotter, 2012. "Downside risk and the energy hedger's horizon," Working Papers 201219, Geary Institute, University College Dublin.

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