The Opportunity Cost of Hedging under Incomplete Information: Evidence from ETF/Ns
Journal of Futures Markets, https://doi.org/10.1002/fut.22252
32 Pages Posted: 9 Jul 2020 Last revised: 30 Jul 2021
Date Written: July 13, 2021
This paper considers the optimal hedge ratio problem under estimation risk. Due to incomplete information, the decision-maker evaluates the opportunity cost of hedging using exchange-traded funds or notes (ETF/Ns). Using a back-testing procedure over the last five years and 13 different hedging instruments - both inverse-equity ETFs and volatility ETNs - we quantify the proposed opportunity cost using different out-of-sample performance metrics. Given the greater accessibility of commission-free brokers for small investors along with the popularity of ETF/Ns, our paper appeals to retail investors and provides guidance in terms of choosing the optimal hedge ratio under estimation risk.
Keywords: Portfolio Hedge, Parameter Uncertainty, Retail Investors, Inverse ETFs, Robinhood
JEL Classification: C13, G11, G12, G50
Suggested Citation: Suggested Citation