Tail Risk Hedging for Mutual Funds Using Equity Market State Prices
Posted: 4 Nov 2016
Date Written: November 1, 2016
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
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