Tail-Risk Protection Trading Strategies

25 Pages Posted: 11 Dec 2015 Last revised: 31 Jul 2018

See all articles by Natalie Packham

Natalie Packham

Berlin School of Economics and Law; Humboldt University Berlin

Jochen Papenbrock


Peter Schwendner

Zurich University of Applied Sciences

Fabian Woebbeking

Halle Institute for Economic Research; Martin Luther University of Halle-Wittenberg

Date Written: August 15, 2016


Starting from well-known empirical stylised facts of financial time series, we develop dynamic portfolio protection trading strategies based on econometric methods. As a criterion for riskiness we consider the evolution of the value-at-risk spread from a GARCH model with normal innovations relative to a GARCH model with generalised innovations. These generalised innovations may for example follow a Student t, a generalized hyperbolic (GH), an alpha-stable or a Generalised Pareto (GPD) distribution. Our results indicate that the GPD distribution provides the strongest signals for avoiding tail risks. This is not surprising as the GPD distribution arises as a limit of tail behavior in extreme value theory and therefore is especially suited to deal with tail risks. Out-of-sample backtests on 11 years of DAX futures data, indicate that the dynamic tail-risk protection strategy effectively reduces the tail risk while outperforming traditional portfolio protection strategies. The results are further validated by calculating the statistical significance of the results obtained using bootstrap methods. A number of robustness tests including application to other assets further underline the effectiveness of the strategy. Finally, by empirically testing for second order stochastic dominance, we find that risk averse investors would be willing to pay a positive premium to move from a static buy-and-hold investment in the DAX future to the tail-risk protection strategy.

Keywords: tail-risk protection, portfolio protection, extreme events, tail distributions, trading strategies

JEL Classification: C10, G11, G17

Suggested Citation

Packham, Natalie and Papenbrock, Jochen and Schwendner, Peter and Woebbeking, Fabian, Tail-Risk Protection Trading Strategies (August 15, 2016). Available at SSRN: https://ssrn.com/abstract=2702275 or http://dx.doi.org/10.2139/ssrn.2702275

Natalie Packham

Berlin School of Economics and Law ( email )

Badensche Strasse 50-51
Berlin, D-10825

HOME PAGE: http://www.packham.net

Humboldt University Berlin ( email )

Unter den Linden 6
Berlin, AK Berlin 10099

Jochen Papenbrock

NVIDIA GmbH ( email )

+49-(0)1741435555 (Phone)

HOME PAGE: http://www.nvidia.com/en-us/industries/finance/

Peter Schwendner

Zurich University of Applied Sciences ( email )

School of Management and Law
Gertrudstrasse 8
Winterthur, CH 8401

Fabian Woebbeking (Contact Author)

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
+49 345 7753-851 (Phone)

HOME PAGE: http://https://www.iwh-halle.de/

Martin Luther University of Halle-Wittenberg

Emil-Abderhalden-Str. 7
Halle an der Saale
06099 Halle (Saale), DE Sachsen-Anhalt 06099

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