On the Measurement of Hedging Effectiveness for Long-Term Investment Guarantees

Author:

Augustyniak Maciej12,Badescu Alexandru3,Boudreault Mathieu24ORCID

Affiliation:

1. Département de Mathématiques et de Statistique, Université de Montréal, P.O. Box 6128, Station Centre-Ville, Montreal, QC H3C 3J7, Canada

2. Quantact Actuarial and Financial Mathematics Laboratory, Centre de Recherches Mathématiques, Université de Montréal, P.O. Box 6128, Station Centre-Ville, Montreal, QC H3C 3J7, Canada

3. Department of Mathematics and Statistics, University of Calgary, 2500 University Drive NW, Calgary, AB T2N 1N4, Canada

4. Département de Mathématiques, Université du Québec à Montréal, P.O. Box 8888, Station Centre-Ville, Montreal, QC H3C 3P8, Canada

Abstract

Although the finance literature has devoted a lot of research into the development of advanced models for improving the pricing and hedging performance, there has been much less emphasis on approaches to measure dynamic hedging effectiveness. This article discusses a statistical framework based on regression analysis to measure the effectiveness of dynamic hedges for long-term investment guarantees. The importance of taking model risk into account is emphasized. The difficulties in reducing hedging risk to an appropriately low level lead us to propose a new perspective on hedging, and recognize it as a tool to modify the risk–reward relationship of the unhedged position.

Funder

Natural Sciences and Engineering Research Council of Canada

Publisher

MDPI AG

Subject

Finance,Economics and Econometrics,Accounting,Business, Management and Accounting (miscellaneous)

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