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Downside risk of derivative portfolios with mean-reverting underlyings




We carry out a Monte-Carlo simulation of a standard portfolio management strategy involving derivatives, to estimate the sensitivity of its downside risk to a change of mean-reversion of the underlyings. We find that the higher the intensity of mean-reversion, the lower the probability of reaching a pre-determined loss level. This phenomenon appears of large statistical significance for large enough loss levels. We also find that the higher the mean-reversion intensity of the underlyings, the longer the expected time to reach those loss levels. The simulations suggest that selecting underlyings with high mean-reversion effect is a natural way to reduce the downside risk of those widely traded assets.

Suggested Citation

  • Leoni, Patrick L., 2009. "Downside risk of derivative portfolios with mean-reverting underlyings," Discussion Papers of Business and Economics 2/2009, University of Southern Denmark, Department of Business and Economics.
  • Handle: RePEc:hhs:sdueko:2009_002

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    References listed on IDEAS

    1. Bakshi, Gurdip & Cao, Charles & Chen, Zhiwu, 1997. " Empirical Performance of Alternative Option Pricing Models," Journal of Finance, American Finance Association, vol. 52(5), pages 2003-2049, December.
    2. Suleyman Basak & Alex Shapiro & Lucie Teplá, 2006. "Risk Management with Benchmarking," Management Science, INFORMS, vol. 52(4), pages 542-557, April.
    3. Patrick Leoni, 2007. "Monte-Carlo Estimations of the Downside Risk of Derivative Portfolios," Economics, Finance and Accounting Department Working Paper Series n1760607, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
    4. Demirer, Riza & Lien, Donald, 2003. "Downside risk for short and long hedgers," International Review of Economics & Finance, Elsevier, vol. 12(1), pages 25-44.
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    More about this item


    Monte Carlo simulation; mean-reverting underlyings;

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • G20 - Financial Economics - - Financial Institutions and Services - - - General


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