Tail risk hedging and regime switching

Huggenberger, Markus ; Albrecht, Peter ; Pekelis, Alexandr

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URL: https://ub-madoc.bib.uni-mannheim.de/41831
URN: urn:nbn:de:bsz:180-madoc-418315
Document Type: Working paper
Year of publication: 2016
The title of a journal, publication series: Mannheimer Manuskripte zu Risikotheorie, Portfolio Management und Versicherungswirtschaft
Volume: 186
Place of publication: Mannheim
Edition: Version 2016
Publication language: English
Institution: Business School > ABWL, Risikotheorie, Portfolio Management u. Versicherungswissenschaft (Albrecht 1989-2021)
Außerfakultäre Einrichtungen > Institut für Versicherungswissenschaft
MADOC publication series: Lehrstuhl für ABWL, Risikotheorie, Portfolio Management und Versicherungswirtschaft (Albrecht) > Mannheimer Manuskripte zu Risikotheorie, Portfolio Management und Versicherungswirtschaft
Subject: 330 Economics
Abstract: We analyze hedging strategies that minimize tail risk measured by Value-at-Risk (VaR) or Conditional-Value-at-Risk (CVaR). In particular, we derive first-order conditions characterizing VaR- and CVaR-minimal hedging with futures in regime-switching models. Using cross-hedging examples, we theoretically and empirically demonstrate that tail-risk-minimal strategies can noticeably deviate from standard minimum-variance policies in the presence of crash regimes. In such examples, VaR- and CVaR-minimal strategies based on regime-switching models are able to attain additional tail risk reductions, which can be confirmed by nonparametric and extreme-value-theory-based meth- ods. These results imply that the proposed methodology for tail risk management can cut losses during financial crises and reduce capital requirements for institutional investors.

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