Abstract
Hedging against tail events has been forcefully advocated in the aftermath of recent global financial crisis. Whether this is beneficial to long horizon investors like defined contribution (DC) plan participants, however, has been subject to criticism. We conduct historical simulation since 1928 to examine the effectiveness of active and passive tail risk hedging using OTM put options for hypothetical DC plan investors with 20 years to retirement. Our findings show that the cost of tail hedging exceeds the benefits for a majority of investors during the sample period. However, for a significant number of simulations, hedging result in superior outcomes relative to an unhedged position. Active hedging proves beneficial when investors confront several panic-driven periods characterized by short and sharp market swings over the investment horizon. Passive hedging, on the other hand, only dominates when investors encounter an extremely rare event like the Great Depression when markets go into deep and prolonged decline.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
