A Profitable Modification to Global Quadratic Hedging
43 Pages Posted: 22 Jun 2018 Last revised: 26 Oct 2019
Date Written: May 23, 2019
Recent research has shown that global quadratic hedging, also known as variance-optimal hedging and mean-variance hedging, can significantly reduce the risk of hedging call and put options with long-term maturities (one year or more), such as Long-Term Equity AnticiPation Securities (LEAPS). We propose a modification to global quadratic hedging that is more profitable on average to the hedger without substantially increasing his downside hedging risk, if at all. We prove mathematically that the expected terminal hedging gain of our modified strategy is greater than that of the global quadratic hedging strategy. The performance of our strategy is evaluated under simulated return paths from GARCH and regime-switching models, and under empirical S&P 500 return paths.
Keywords: Risk Management, Variance-Optimal Hedging, Mean-Variance Hedging, Global Risk-Minimization, LEAPS
JEL Classification: C22, C61, G32
Suggested Citation: Suggested Citation