Tail Risk Hedging for Mutual Funds Using Equity Market State Prices

Posted: 4 Nov 2016

See all articles by Michael O'Neill

Michael O'Neill

Bond University - Bond Business School

Zhangxin Frank Liu

The University of Western Australia Business School

Date Written: November 1, 2016

Abstract

This paper proposes a method for generating unbiased predictors of downside and tail volatility for individual mutual funds, using theoretical market state prices and applying these to fund payoffs. The method is validated as a predictor of market downside and tail volatility. The Fund Volatility Index-Lower Partial Moment (FVX⁻) is then proposed as a forward-looking hedge of downside volatility for funds, calibrated and assessed on a database of 13,202 individual funds. The method proves to be unbiased with high forecast accuracy and is capable of capturing individual fund skewness.

Keywords: mutual fund, state price volatility

Suggested Citation

O'Neill, Michael and Liu, Zhangxin (Frank), Tail Risk Hedging for Mutual Funds Using Equity Market State Prices (November 1, 2016). Australian Journal of Management, Vol. 41, No. 4, 2016, Available at SSRN: https://ssrn.com/abstract=2864531

Michael O'Neill (Contact Author)

Bond University - Bond Business School ( email )

Gold Coast
Australia

Zhangxin (Frank) Liu

The University of Western Australia Business School ( email )

School of Business
35 Stirling Highway
Crawley, Western Australia 6009
Australia

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