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The opportunity cost of hedging under incomplete information: Evidence from ETF/Ns

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  • Zhenyu Cui
  • Majeed Simaan

Abstract

This paper considers the optimal hedge ratio problem under estimation risk. Due to incomplete information, the decision‐maker evaluates the opportunity cost of hedging using exchange‐traded funds or notes (ETF/Ns). Using a backtesting procedure over the last 5 years and 13 different hedging instruments—both inverse‐equity ETFs and volatility ETNs—we quantify the proposed opportunity cost using different out‐of‐sample performance metrics. Given the greater accessibility of commission‐free brokers for small investors along with the popularity of ETF/Ns, our paper appeals to retail investors and provides guidance in terms of choosing the optimal hedge ratio under estimation risk.

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  • Zhenyu Cui & Majeed Simaan, 2021. "The opportunity cost of hedging under incomplete information: Evidence from ETF/Ns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(11), pages 1775-1796, November.
    • Handle: RePEc:wly:jfutmk:v:41:y:2021:i:11:p:1775-1796
    DOI: 10.1002/fut.22252
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