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A Framework for Constructing Equity-Risk-Mitigation Portfolios

Author

Listed:
  • Jamil Baz
  • Josh Davis
  • Steve Sapra
  • Normane Gillmann
  • Jerry Tsai

Abstract

The key trade-off among equity-risk-mitigation strategies is their expected return versus their ability to diversify equity risk. In particular, the more reliable a strategy’s equity-hedging properties, the lower its expected return, and vice versa. This article proposes a framework for optimal equity-risk-mitigation portfolio construction. In our model, the investor maximizes the portfolio’s unconditional expected return, subject to a constraint on its conditional equity beta. We show that the return to a risk-mitigation portfolio can be decomposed into hedging and return- generating components. We then demonstrate that optimal risk-mitigation portfolios exhibit better return-defensiveness properties relative to the underlying strategies.Disclosure: The authors report no conflicts of interest. Editor’s Note Submitted 17 June 2019Accepted 14 April 2020 by Stephen J. Brown

Suggested Citation

  • Jamil Baz & Josh Davis & Steve Sapra & Normane Gillmann & Jerry Tsai, 2020. "A Framework for Constructing Equity-Risk-Mitigation Portfolios," Financial Analysts Journal, Taylor & Francis Journals, vol. 76(3), pages 81-98, July.
    • Handle: RePEc:taf:ufajxx:v:76:y:2020:i:3:p:81-98
    DOI: 10.1080/0015198X.2020.1758502
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