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

See all articles by Zhenyu Cui

Zhenyu Cui

Stevens Institute of Technology - School of Business

Majeed Simaan

Stevens Institute of Technology - School of Business

Date Written: July 13, 2021

Abstract

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

Cui, Zhenyu and Simaan, Majeed, The Opportunity Cost of Hedging under Incomplete Information: Evidence from ETF/Ns (July 13, 2021). Journal of Futures Markets, https://doi.org/10.1002/fut.22252 , Available at SSRN: https://ssrn.com/abstract=3643958 or http://dx.doi.org/10.2139/ssrn.3643958

Zhenyu Cui

Stevens Institute of Technology - School of Business ( email )

Hoboken, NJ 07030
United States

HOME PAGE: http://sites.google.com/site/zhenyucui86/publications

Majeed Simaan (Contact Author)

Stevens Institute of Technology - School of Business ( email )

Hoboken, NJ 07030
United States

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