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When to Hedge Downside Risk?

Author

Listed:
  • Christos I. Giannikos

    (Graduate Center and Baruch College, City University of New York, 365 5th Ave, New York, NY 10016, USA)

  • Hany Guirguis

    (The O’Malley School of Business, Manhattan College, Riverdale, NY 10471, USA)

  • Andreas Kakolyris

    (School of Accounting and Finance, College of Business and Public Management, Kean University, Union, NJ 07083, USA)

  • Tin Shan (Michael) Suen

    (School of Accounting and Finance, College of Business and Public Management, Kean University, Union, NJ 07083, USA)

Abstract

Hedging downside risk before substantial price corrections is vital for risk management and long-only active equity manager performance. This study proposes a novel methodology for crafting timing signals to hedge sectors’ downside risk. These signals can be integrated into existing strategies simply by purchasing sector index put options. Our methodology generates successful signals for price corrections in 2000 (dot-com bubble) and 2008 (global financial crisis). A key innovation involves utilizing sector correlations. Major price swings within six months are signaled when a sector exhibits high valuation alongside abnormal correlations with others. Utilizing the price-to-earnings ratio for identifying sectors’ high valuations is more beneficial than the bond–stock earnings yield differential. Our signals are also more efficient than those of standard technical analyses.

Suggested Citation

  • Christos I. Giannikos & Hany Guirguis & Andreas Kakolyris & Tin Shan (Michael) Suen, 2024. "When to Hedge Downside Risk?," Risks, MDPI, vol. 12(2), pages 1-20, February.
    • Handle: RePEc:gam:jrisks:v:12:y:2024:i:2:p:42-:d:1341077
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    References listed on IDEAS

    as
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    4. Cajueiro, Daniel O. & Tabak, Benjamin M. & Werneck, Filipe K., 2009. "Can we predict crashes? The case of the Brazilian stock market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 388(8), pages 1603-1609.
    5. Fu, Junhui & Wu, Xiang & Liu, Yufang & Chen, Rongda, 2021. "Firm-specific investor sentiment and stock price crash risk," Finance Research Letters, Elsevier, vol. 38(C).
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