Portfolio Hedging Strategies Research Articles

The dynamic connectedness between collateralized loan obligations and major asset classes: a TVP-VAR approach and portfolio hedging strategies for investors

Motivated by the increasing demand for alternative assets that can contribute to reducing portfolio risk, this paper examines the volatility spillovers between collateralized loan obligations (CLOs) and various in-demand investment instruments, including equities, bonds, crude oil, commodities, gold, bitcoin, shipping and real estate. The applied methodology comprehends the time-varying parameter vector autoregressive (TVP-VAR) modification of the classical spillover approach, for the period from January 1, 2012, to August 31, 2023. The empirical findings show moderate levels of dynamic connectedness; albeit several external shocks strengthened the interconnection among the assets. Moreover, we compare the ability of CLOs for hedging, during the overall sample period and multiple subperiods, by estimating hedge ratios and optimal portfolio weights, in order to inform investors about feasible portfolio adjustments. Our results indicate that CLOs constitute an effective hedging tool, irrespective of the period covered, as the short position in their volatility provides high hedging effectiveness for investors holding long positions in the volatility of all the remaining assets.

Portfolio Hedging Strategy - Metals and Commodities

From the perspective of portfolio management, hedging is a proactive risk management measure that aims to protect the portfolio from unwanted drawdown risk and avoid loss on investment by incorporating assets into a portfolio which moves in the opposite direction as the market. However, trying to limit the risk could result in limiting potential profits. Commodities are one of the best hedges against inflation as their price typically accelerates during such times providing benefit to the investor. We use the innovative approach of hedging commodities using a combination of CAPM and RSI Strategy to identify which of 9 observed hard commodities (Aluminium, Zinc, Nickel, Lead, Tin, Copper, Gold, Brent Oil and Natural Gas) should have been incorporated into investment portfolio during the period 2008-2023. The SML strategy is reviewed in the empirical analysis for its suitability as a hedging instrument compared to the RSI, which is regularly used to hedge metals and commodities. Our MS Excel and IBM SPSS software analysis showed that RSI was a better hedging strategy than SML in 21 out of 36 cases but without statistical significance.

Return-volatility relationships in cryptocurrency markets: Evidence from asymmetric quantiles and non-linear ARDL approach

Implied volatility has consistently demonstrated its reliability as a superior estimator of the expected short-term volatility of underlying assets. In this study, we employ the newly constructed robust model-free implied volatility (MFIV) indices for Bitcoin and Ethereum (BitVol and EthVol) to explore the asymmetric return-volatility relationship of these cryptocurrencies through the lens of behavioral finance theories. Utilizing the asymmetric quantile regression model (QRM) and the Non-linear ARDL (NARDL) approach, our results reveal a notable difference from equities. Both positive and negative return shocks in the cryptocurrency market lead to an increase in volatility. However, during high volatility regimes, positive (negative) return shocks exert a more substantial impact on positive innovations of volatility for Bitcoin (Ethereum) compared to negative (positive) return shocks. The degree of asymmetry steadily intensifies as we progress from medium to uppermost quantiles of the volatility distribution. These observed phenomena can be attributed to behavioral aspects among market participants, including noise trading, behavioral biases, and fear of missing out (FOMO). Our findings hold significant implications for various aspects of cryptocurrency trading, portfolio hedging strategies, volatility derivatives pricing, and risk management.

The dynamic connectedness between private equities and other high-demand financial assets: A portfolio hedging strategy during COVID-19

In view of the need for portfolio diversification, we investigate the interlinkages between a private equity ETF and a set of high-demand asset classes including bonds, equities, crude oil, gold, commodities, currency, Bitcoin, and shipping within a spillover framework. For this objective, we apply the enhanced modification of the Diebold and Yilmaz approach for the period 1 January 2010 to 31 January 2023. The empirical findings indicate a modest degree of connectedness among the investigated markets, whereas volatility spillovers showed acceleration during tumultuous periods. In addition, we assess the capacity of private equities for hedging, for the whole sample period and during COVID-19 infectious disease, in order to suggest investors for potential portfolio restructures. Results demonstrate that the short position in the volatility of private equity ETF can result in strong hedging effectiveness for investors holding long positions in Bitcoin, shipping, bonds, and crude oil. JEL Classification: C32, C58, G11, G15

Realized semi variance quantile connectedness between oil prices and stock market: Spillover from Russian-Ukraine clash

This study aims to investigate the dynamic relationship between oil prices and stock markets in the G5+ countries using Parkinson's proximal realized volatility. We separate positive and negative semi-variance to compute asymmetric aggregate static spillovers according to the Diebold and Yilmaz (DY) approach. Moreover, we use a Quantile VAR to investigate the behavior of series in different quantiles corresponding to different market scenarios. Consistently with the literature concerns, we use a daily sample of market indices prices with the Brent oil price from June 1, 2017, to July 2, 2022. We found an asymmetric linkage between oil prices and the stock market, which has significant implications for portfolio hedging strategies. Specifically, our research indicates that the impact of the Russian-Ukrainian conflict on the energy crisis has been significantly higher than that of the COVID-19 pandemic, especially in the short term. However, we observe a higher persistence of negative spillovers for COVID-19 compared to those recorded during the Russia-Ukraine war. From a methodological viewpoint, this result enforces the choice of an asymmetric model to investigate the volatility transmission between financial market series. Finally, we found crude oil to emit volatility spillovers in quantiles above 80%. This result emphasizes the instability perceived in crude oil price when general market volatility increase. Quite the opposite, about one-third of oil price shocks, are linked to the national stock exchange uncertainty in low and middle quantiles, underlining the investors' dependency on this commodity. These results have important implications for policymakers and institutional authorities, who must consider the changing macroeconomic environment and reduce dependence on Russian energy.

The reaction of the metal and gold resource planning in the post-COVID-19 era and Russia-Ukrainian conflict: Role of fossil fuel markets for portfolio hedging strategies

The prime objective of this article is to examine the policy-making role of metal markets, gold resources, and clean energy markets in the post-COVID-19 era and the Russia-Ukrainian military conflict. In doing so, we analyze the role of fossil fuels, clean energy, and metals markets, considering the military conflict in Ukraine in 2022. The study employs event study methodology (ESM), Total connectedness index (TCI), and network analyses. The results indicate that natural gas and clean energy prices are less affected by conflict in the aftermath of an invasion than traditional energy and metals markets. In addition, we observe an increase in the TCI in the energy markets during announcement days. The TCI of the metals market is greater than that of the energy market. According to network connectivity, the key asset class transmitters of the shock in Europe are the Geopolitical index (GPR), gold, and the clean energy stock index (ERIX). The U.S. markets are less affected by the situation in Ukraine. The average hedge suggests that the optimal hedge differs from one market to the next, with fossil fuels and renewable energy, respectively, being more hedge effective and reducing risk by an average of around 0.80 and 0.59, given their ability to function as a hedging instrument.

Are Bitcoin and Gold a Safe Haven during COVID-19 and the 2022 Russia–Ukraine War?

Our investigation strives to unearth the best portfolio hedging strategy for the G7 stock indices through Bitcoin and gold using daily data relevant to the period 2 January 2016 to 5 January 2023. This study uses the DVECH-GARCH model to model dynamic correlation and then compute optimal hedge ratios and hedging effectiveness. The empirical findings show that Bitcoin and gold were rather effective hedge assets before COVID-19 and diversifiers during the pandemic and Russia–Ukraine war. From hedging effectiveness perspectives, gold and Bitcoin are safe-haven assets, and the investment risk of G7 stock indices could be hedged by taking a short position during thepandemic period and war except for the pair Nikkei/Gold. Additionally, gold beats Bitcoin in terms of hedging efficiency. We thus demonstrate the central role of Bitcoin and gold as financial market participants, particularly during market turmoil and downward movements. Our findings can be of interest to investors, regulators, and governments to take into consideration the role of Bitcoin in financial markets.

Can treasury inflation-protected securities safeguard investors from outward risk spillovers? A portfolio hedging strategy through the prism of COVID-19

Documenting the interlinkages among assets that are widely used to hedge against inflation is crucial for investors, as the necessity to protect the investment portfolio is stronger under inflationary conditions. For this purpose, we investigate the volatility spillovers between treasury inflation-protected securities (TIPS) and a battery of other assets perceived as inflation hedges, including bonds, gold, real estate, oil and equities. The applied methodology comprehends the time-varying parameter vector autoregressive (TVP-VAR) extension of the Diebold and Yilmaz (Int J Forecast 28:57–66, 2012, 10.1016/j.ijforecast.2011.02.006) approach for the period 1/1/2010–3/31/2022. Our results indicate that the assets under consideration are moderately interconnected and subjected to several exogenous shocks, such as the US–China trade war, the COVID-19 pandemic and the Russia–Ukraine war. Furthermore, we assess the hedging effectiveness of TIPS against each asset by estimating hedge ratios and optimal portfolios weights, before and after the spread of COVID-19 pandemic, by using conditional variance estimations (DCC-GARCH). The empirical findings show that the short position in the volatility of TIPS is proved to be an excellent hedge for all the sampled assets, with the exception of short-term Treasury bonds, and their hedging ability was improved during COVID-19.

Value investing versus other investment strategies: A volatility spillover approach and portfolio hedging strategies for investors

Motivated by the incessant demand for portfolio diversification, this study examines the connectedness between value and diverse types of stocks (growth, momentum, ESG, high beta, classic S&P 500, volatility). The applied methodology encompasses the time-varying parameter vector autoregressive (TVP-VAR) extension of the Diebold and Yilmaz (2012) framework for the period from 03/31/2011 to 03/31/2021. Results show moderate volatility transmissions among the sampled assets, which tend to escalate during periods of turmoil, such as the European Sovereign Debt Crisis, the plunge in oil prices and the COVID-19 outbreak. Growth and ESG stocks play an indispensable part in the transmission mechanism. Moreover, we investigate the hedging ability of value stocks within a portfolio containing other stocks, by estimating hedge ratios and optimal weights with the usage of conditional variance estimates (DCC-GARCH). The empirical findings reveal that value stocks can adequately hedge against the risk deriving from the volatility of the remaining investment instruments, especially in the case of high beta and volatility stocks. Thus, this analysis provides portfolio managers and investors with valuable insights in order for them to hedge their stock portfolios effectively.

Volatility spillovers between fine wine and major global markets during COVID-19: A portfolio hedging strategy for investors

Motivated by the growing necessity of portfolio diversification, this paper investigates the dynamic connectedness among fine wine, equities, bonds, crude oil, commodities, gold, copper, shipping and real estate by applying the Diebold and Yilmaz (2012) approach, based on the time-varying parameter vector autoregressive (TVP-VAR) model of Antonakakis et al. (2020), for the period 1/1/2010-5/31/2021. Our results indicate moderate volatility spillovers among the markets over time, whereas total connectedness is prone to exogenous shocks, reaching its peak during stress periods. Equities, crude oil, gold and fine wine are the net contributors of spillovers, whereas real estate, commodities, copper, bonds and shipping constitute the net receivers of the diffused shocks. Furthermore, we estimate and compare the hedging ability of fine wine, before and after the emergence of the coronavirus pandemic, to instruct investors in rebalancing their portfolio strategies during COVID-19. The empirical findings suggest that fine wine can form an effective hedging tool to reduce the risk deriving from adverse movements of the markets and its hedging ability was enhanced during COVID-19, with few exceptions. Regardless time period, the highest hedging effectiveness can be achieved by taking a long position in the volatility of crude oil and a short position in the volatility of fine wine.

Are timber and water investments safe-havens? A volatility spillover approach and portfolio hedging strategies for investors

Using a time-varying spillover approach, we investigate volatility spillovers between natural alternative investments, i.e. timber and water, and a battery of traditional instruments comprising equities, bonds, crude oil, gold, real estate, shipping and currency, for the period 1/1/2010–9/30/2021. Results show that the sample markets are moderately integrated and total connectedness escalated during stress periods. Moreover, we examine the hedging ability of timber and water by constructing optimal hedge ratios and portfolio weights. Both assets constitute an effective hedging tool for shipping, crude oil and bond investors, with the short position in the volatility of water to provide higher hedging effectiveness.

Are ESG stocks safe-haven during COVID-19?

PurposeThe purpose of this study is to investigate safe-haven properties of environmental, social and governance (ESG) stocks in global and emerging ESG stock markets during the times of COVID-19 so that portfolio managers and equity market investors could decide to use ESG stocks in their portfolio hedging strategies during times of health and market crisis similar to COVID-19 pandemic.Design/methodology/approachThe study uses a wavelet coherence framework on four major ESG stock indices from global and emerging stock markets, and two proxies of COVID-19 fear over the period from 5 February 2020 to 18 March 2021.FindingsThe results of the study show a positive co-movement of the global COVID-19 fear index (GFI) with ESG stock indices on the frequency band of 32 to 64 days, which confirms hedging and safe-haven properties of ESG stocks using the health fear proxy of COVID-19. However, the relationship between all indices and GFI is mixed and inconclusive on a frequency of 0–8 days. Further, the findings do not support the safe-haven characteristics of ESG indices using the market fear proxy (IDEMV index) of COVID-19. The robustness analysis using the CBOE VIX as a proxy of market fear supports that ESG indices do not possess safe-haven properties. The results of the study conclude that the safe-haven properties of ESG indices during the ongoing COVID-19 pandemic is contingent upon the proxy of COVID-19 fear.Practical implicationsThe findings have important implications for the equity investors and assetty managers to improve their portfolio performance by including ESG stocks in their portfolio choice during the COVID-19 pandemic and similar health crisis. However, their investment decisions could be affected by the choice of COVID-19 proxy.Originality/valueThe authors believe in the originality of the paper due to following reasons. First, to the best of the knowledge, this is the first study investigating the safe-haven properties of ESG stocks. Second, the authors use both health fear (GFI) and market fear (IDEMV index) proxies of COVID-19 to compare whether safe-haven properties are characterized by health fear or market fear due to COVID-19. Finally, the authors use the wavelet coherency framework, which not only takes both time and frequency dimensions of the data into account but also remains unaffected by data stationarity and size issues.

Loss of structural balance in stock markets

We use rank correlations as distance functions to establish the interconnectivity between stock returns, building weighted signed networks for the stocks of seven European countries, the US and Japan. We establish the theoretical relationship between the level of balance in a network and stock predictability, studying its evolution from 2005 to the third quarter of 2020. We find a clear balance–unbalance transition for six of the nine countries, following the August 2011 Black Monday in the US, when the Economic Policy Uncertainty index for this country reached its highest monthly level before the COVID-19 crisis. This sudden loss of balance is mainly caused by a reorganization of the market networks triggered by a group of low capitalization stocks belonging to the non-financial sector. After the transition, the stocks of companies in these groups become all negatively correlated between them and with most of the rest of the stocks in the market. The implied change in the network topology is directly related to a decrease in stock predictability, a finding with novel important implications for asset allocation and portfolio hedging strategies.

Portfolio management and dependence structure between cryptocurrencies and traditional assets: evidence from FIEGARCH-EVT-Copula

The purpose of this paper is twofold. Firstly, it discusses the relationship between five cryptocurrencies, oil prices, and US indices. Secondly, it focuses on determining the best portfolio hedging strategy. Using daily data relevant to the period ranging from January 4, 2016, to November 29, 2019, this study applies the FIEGARCH-EVT-Copula and Hedge ratios analysis. The findings obtained have shown that the crude oil (WTI) and the US indices return highlights the persistence of a negative and significant leverage effect while the cryptocurrency markets present a positive asymmetric volatility effect. Moreover, this paper show evidence of very weak dependence between all the different pairs considered before and after the introduction of Bitcoin Futures. Based on the Hedging ratio and mean-variance approach, this article suggests that to minimize the risk while keeping the same expected returns of the digital-conventional financial asset portfolio, the investor should hold more conventional financial assets than digital assets except for WTI-Bitcoin, WTI- Dash and WTI-Ethereum pairs which the values of their hedge ratios are rather important with respect to OLS regression.

Gold, inflation and exchange rate in dollarized economies – A comparative study of Turkey, Peru and the United States

This paper conducts a comprehensive empirical study on gold’s hedging potential against adverse movements of inflation and exchange rates for three countries: Turkey (highly dollarized), Peru (low dollarized) and United States (benchmark). With the use of quantile-on-quantile regression (QQR) and quantile-on-quantile correlation (QQCOR) models, we find that gold can offer protection against currency movements and inflation fluctuation at all times for Turkey and the United States, but fail to do so during Turkey’s hyperinflationary period; in Peru, gold is a good hedge if the change of CPI is above 3.29% or currency depreciation rate is above 3.24%. We reveal that the conclusion of gold acting as a hedge (safe haven) against inflation or exchange rate volatility conjoin to both the gold market condition and the nature of macroeconomic shocks. Moreover, we use the QQCOR results into a portfolio hedging strategy and further confirm gold’s usefulness in portfolio risk management in terms of return accumulation and risk reduction with respect to a currency only investment.

Optimal option portfolio hedging strategy with non-Gaussian fluctuations

Optimal option portfolio hedging strategy with non-Gaussian fluctuations

Optimal option portfolio hedging strategy with non-Gaussian fluctuations

The third and fourth moments are two important factors in designing the optimal hedge strategy. This paper investigates the problem of futures hedging under the third and fourth moment based on the multi-objective programming. As the price of the underlying asset changes over time, delta of the option changes and a gamma hedge is required along with delta hedge to reduce risk. This motivates us to find an improvement in delta approximation for various models as well as to investigate the extent of such improvement across fourth moment models. We develop in this work a new framework of risk measure via the fourth moment order of expected utility which is more sensitive to large fluctuations in the variance and risk aversion. Results show that the new approach of Delta optimisation with expected utility ensure significant improvement in modelling option prices leading to better risk-management decision-making.

Risk-sharing finance governance: Islamic vs conventional indexes option pricing

PurposeRisk governance has an important influence on the hedging performances in option pricing and portfolio hedging in both discrete and dynamic case for both conventional and Islamic indexes. The paper aims to discuss these issues.Design/methodology/approachThis paper explores option pricing and portfolio hedging in a discrete and dynamic case with transaction costs. Monte Carlo simulations are applied to both conventional and Islamic indexes in US and UK markets. Simulations show that conventional and Islamic assets do not exhibit the same price and portfolio hedging strategy governance.FindingsThe authors conclude that Islamic assets show different option price and hedging strategy compared to their conventional counterpart.Originality/valueThe research question of this paper aims at filling the gap in the empirical literature by exploring option price and hedging structure for both conventional and Islamic indexes in US and UK stock markets.

A revisit to stock market contagion and portfolio hedging strategies

PurposeThis paper aims to attempt to re-capture the stock market contagion effect from the US to the BRIC equity markets during the recent global financial crisis in a multivariate framework. Apart from this, the study also identifies optimal portfolio hedging strategies to minimize the underlying portfolio risk during the period undertaken for the purpose of study.Design/methodology/approachTo account for the dynamic interactions, the study uses vector autoregression (p) dynamic conditional correlation (DCC)-asymmetric generalized autoregressive conditional heteroskedastic (1,1) model in a multivariate framework, coupled with a monthly heat map relating to the co-movement between the US and the BRIC equity markets during the period 2007-2009. Finally, by following the studies, Hammoudeh et al. (2010) and Syriopoulos et al. (2015), the time-varying optimal portfolio hedge ratios and weights are computed.FindingsThe results report a contagion impact of the US subprime crisis (following the collapse of the Lehman Brothers) on the Indian and Russian stock markets only. On the other hand, a higher degree of interdependence between the US and Brazilian market has been observed. The US and Chinese equity markets indicate a relatively lower level of interdependence among themselves. The optimal hedge ratios are found to be most effective for a portfolio comprising the US and Chinese stocks even during the crisis period. A US investor should invest approximately 30 cents in the Indian market and rest of the 70 cents in the US market in a US$1 portfolio to minimize the portfolio risk without lowering the expected returns. During the crisis period (2007-2009), the optimal portfolio weights indicate a higher weightage to the BRIC stocks.Practical implicationsThe results support the construction of optimal US–BRIC stock portfolios and provide an insight to the investors and policy makers both domestic as well as international, with regard to the contagion impact and interdependence, especially during a crisis period.Originality/valueThe study uses a DCC model in a multivariate framework instead of bivariate, wherein all the markets are factored into a single interaction framework across a very long period (2004-2014). Second, a heat map of monthly correlation combinations has been created for the period 2007-2009, to comprehend the contagion impact or interdependence among the markets. Finally, the study ascertains time-varying optimal hedge ratios and portfolio weights for a two asset portfolio, from a US investor viewpoint, making the study first of its kind in all the perspectives.

Black swan events and safe havens: The role of gold in globally integrated emerging markets

There is evidence to suggest that gold acts as both a hedge and a safe haven for equity markets over recent years, and particularly during crises periods. Our work extends the recent literature on hedging and diversification roles of gold by analyzing its interaction with the stock markets of the leading emerging economies, the BRICS. While they generally exhibit a high growth rate, these economies still experience a pronounced vulnerability to external shocks, particularly to commodity price fluctuations. Using a multi-scale wavelet approach and a GARCH-based copula methodology, we mainly show evidence of: (i) the time-scale co-evolvement patterns between BRICS stock markets and gold market, with some profound regions of concentrated extreme variations; and (ii) a strong time-varying asymmetric dependence structure between those markets. These findings are essential for risk diversification and portfolio hedging strategies among the investigated markets.