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Dynamic Hedging and Extreme Asset Co-movements

Author

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  • Redouane Elkamhi
  • Denitsa Stefanova

Abstract

The paper investigates the portfolio allocation effects of increased asset co-movements during market downturns. We develop a model for the stock price process that allows for increased and asymmetric dependence between extreme return realizations. We isolate the portfolio hedging demands that arise due to extreme co-movements and find a substantial shift of the portfolio holdings toward the risk-free asset. We demonstrate that accounting for dependence between extreme events in portfolio decisions leads to significant economic gains that stem primarily from intertemporal hedging motives. These findings are robust along alternative modeling assumptions of extreme co-movements and conditional correlation.

Suggested Citation

  • Redouane Elkamhi & Denitsa Stefanova, 2015. "Dynamic Hedging and Extreme Asset Co-movements," The Review of Financial Studies, Society for Financial Studies, vol. 28(3), pages 743-790.
    • Handle: RePEc:oup:rfinst:v:28:y:2015:i:3:p:743-790.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhu074
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    Cited by:

    1. Redouane Elkamhia & Denitsa Stefanova, 2011. "Dynamic Correlation or Tail Dependence Hedging for Portfolio Selection," Tinbergen Institute Discussion Papers 11-028/2/DSF10, Tinbergen Institute.
    2. Branger, Nicole & Mahayni, Antje & Zieling, Daniel, 2015. "Robustness of stable volatility strategies," Journal of Economic Dynamics and Control, Elsevier, vol. 60(C), pages 134-151.
    3. Wang, Ze & Gao, Xiangyun & An, Haizhong & Tang, Renwu & Sun, Qingru, 2020. "Identifying influential energy stocks based on spillover network," International Review of Financial Analysis, Elsevier, vol. 68(C).
    4. Fousseni Chabi-Yo & Markus Huggenberger & Florian Weigert, 2019. "Multivariate Crash Risk," Working Papers on Finance 1901, University of St. Gallen, School of Finance.

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