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.
|Date of creation:||02 Jan 2009|
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- Charles Quanwei Cao & Gurdip S. Bakshi & Zhiwu Chen, 1997.
"Empirical Performance of Alternative Option Pricing Models,"
Yale School of Management Working Papers
ysm65, Yale School of Management.
- Bakshi, Gurdip & Cao, Charles & Chen, Zhiwu, 1997. " Empirical Performance of Alternative Option Pricing Models," Journal of Finance, American Finance Association, vol. 52(5), pages 2003-49, December.
- Charles Quanwei Cao & Gurdip S. Bakshi & Zhiwu Chen, 1997. "Empirical Performance of Alternative Option Pricing Models," Yale School of Management Working Papers ysm54, Yale School of Management.
- Basak, Suleyman & Shapiro, Alex & Teplá, Lucie, 2005.
"Risk Management with Benchmarking,"
CEPR Discussion Papers
5187, C.E.P.R. Discussion Papers.
- 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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