The University of Southampton
University of Southampton Institutional Repository

Hedging demand in long-term asset allocation with an application to carry trade strategies

Hedging demand in long-term asset allocation with an application to carry trade strategies
Hedging demand in long-term asset allocation with an application to carry trade strategies
We derive a closed-form expression for the mean and marginal hedging demand on risky assets in long-term asset allocation problems for individuals with CRRA preferences. Our parametric portfolio policy rule accommodates an arbitrarily large number of state variables for predicting the state of nature, and number of assets in the portfolio. The closedform expression for the hedging demand is exact under polynomial specifications of the portfolio policy rule and a suitable approximation for unknown smooth parametric portfolio policy rules using Taylor expansions. The hedging demand on risky assets depends positively on the predictability of the risky asset and the persistence of the predictors, and negatively on the degree of investor’s relative risk aversion. We illustrate these insights empirically for a basket of currencies by showing the outperformance of rebalancing carry trade strategies over different investment horizons against a short-term (myopic) portfolio
1479-8409
Laborda, Ricardo
c50eae59-9323-4cb0-a418-d51dd42c9986
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e
Laborda, Ricardo
c50eae59-9323-4cb0-a418-d51dd42c9986
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e

Laborda, Ricardo and Olmo, Jose (2020) Hedging demand in long-term asset allocation with an application to carry trade strategies. Journal of Financial Econometrics. (In Press)

Record type: Article

Abstract

We derive a closed-form expression for the mean and marginal hedging demand on risky assets in long-term asset allocation problems for individuals with CRRA preferences. Our parametric portfolio policy rule accommodates an arbitrarily large number of state variables for predicting the state of nature, and number of assets in the portfolio. The closedform expression for the hedging demand is exact under polynomial specifications of the portfolio policy rule and a suitable approximation for unknown smooth parametric portfolio policy rules using Taylor expansions. The hedging demand on risky assets depends positively on the predictability of the risky asset and the persistence of the predictors, and negatively on the degree of investor’s relative risk aversion. We illustrate these insights empirically for a basket of currencies by showing the outperformance of rebalancing carry trade strategies over different investment horizons against a short-term (myopic) portfolio

Text
Hedging demand Laborda Olmo final - Accepted Manuscript
Restricted to Repository staff only until 21 August 2022.
Request a copy

More information

Accepted/In Press date: 21 August 2020

Identifiers

Local EPrints ID: 443967
URI: http://eprints.soton.ac.uk/id/eprint/443967
ISSN: 1479-8409
PURE UUID: 8ab68d8b-2055-4842-a478-433b5384d5d6
ORCID for Jose Olmo: ORCID iD orcid.org/0000-0002-0437-7812

Catalogue record

Date deposited: 18 Sep 2020 16:31
Last modified: 18 Feb 2021 17:21

Export record

Download statistics

Downloads from ePrints over the past year. Other digital versions may also be available to download e.g. from the publisher's website.

View more statistics

Atom RSS 1.0 RSS 2.0

Contact ePrints Soton: eprints@soton.ac.uk

ePrints Soton supports OAI 2.0 with a base URL of http://eprints.soton.ac.uk/cgi/oai2

This repository has been built using EPrints software, developed at the University of Southampton, but available to everyone to use.

We use cookies to ensure that we give you the best experience on our website. If you continue without changing your settings, we will assume that you are happy to receive cookies on the University of Southampton website.

×