Full-Scale Optimization: A Flexible Framework for Hedge Design

Peregrine Securities, 2014

28 Pages Posted: 22 Apr 2016

See all articles by Anthony Seymour

Anthony Seymour

University of Cape Town (UCT)

Florence Chikurunhe

Peregrine Securities

Emlyn James Flint

Legae Peresec; Department of Actuarial Science, University of Cape Town

Date Written: August 11, 2014

Abstract

In this work we consider the application of expected utility optimization to the construction of an optimal hedge. Utility theory provides a rich framework for decision-making under uncertainty and features preferences specified via a range of simple to possibly complex functions of future portfolio returns. Optimal hedge construction examples are discussed in the context of downside protection for domestic equity, and the reduction of currency exposure risk inherent in a foreign equity position. We also quantify the impact of currency derivatives on the risk and return properties of a foreign equity holding. This is done by considering two types of preference specification featuring loss aversion, namely kinked utility and S-shaped utility. Both of these functions have particular relevance for fund managers concerned with the value of a portfolio falling below that of a benchmark, or a pension fund becoming underfunded at a certain point.

Keywords: full scale optimization, hedge design, portfolio construction

JEL Classification: C14, C15, C61, G11

Suggested Citation

Seymour, Anthony and Chikurunhe, Florence and Flint, Emlyn James, Full-Scale Optimization: A Flexible Framework for Hedge Design (August 11, 2014). Peregrine Securities, 2014. Available at SSRN: https://ssrn.com/abstract=2767430 or http://dx.doi.org/10.2139/ssrn.2767430

Anthony Seymour

University of Cape Town (UCT) ( email )

Private Bag X3
Rondebosch, Western Cape 7701
South Africa

Florence Chikurunhe

Peregrine Securities ( email )

21 Main Road
Claremont
Cape Town, Western Cape 7700
South Africa
+27117227551 (Phone)

HOME PAGE: http://www.peregrine.co.za

Emlyn James Flint (Contact Author)

Legae Peresec ( email )

15 Cavendish Street
Claremont
Cape Town, Western Cape 7700
South Africa
27117227556 (Phone)

HOME PAGE: http://www.legaeperesec.co.za

Department of Actuarial Science, University of Cape Town ( email )

Actuarial Science Section, University of Cape Town
Private Bag X3, Rondebosch
Cape Town, Western Cape 7701
South Africa
+27 21 650 2475 (Phone)

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