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Risks 2018, 6(4), 112; https://doi.org/10.3390/risks6040112

Hedge or Rebalance: Optimal Risk Management with Transaction Costs

1
Swissquote, Chemin de la Crétaux 33, 1196 Gland, Switzerland
2
Swiss Finance Institute, Boulevard du Pont-d’Arve 40, 1205 Genéve, Switzerland
3
Ecole Polytechnique Fédérale de Lausanne, UNIL Dorigny, 1015 Lausanne, Switzerland
4
Centre for Economic Policy Research, 33 Great Sutton St, Clerkenwell, London EC1V 0DX, UK
*
Author to whom correspondence should be addressed.
Received: 4 July 2018 / Revised: 24 August 2018 / Accepted: 14 September 2018 / Published: 8 October 2018
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Abstract

We solve the problem of optimal risk management for an investor holding an illiquid, alpha-generating fund and hedging his/her position with a liquid futures contract. When the investor is subject to a lower bound on net return, he/she is forced to reduce the total risk of his/her portfolio after a loss. In this case, he/she faces a tradeoff of either paying the transaction costs and deleveraging or keeping his/her current position in the illiquid instrument and hedging away some of the risk while keeping the residual, unhedgeable risk on his/her balance sheet. We explicitly characterize this tradeoff and study its dependence on asset characteristics. In particular, we show that higher alpha and lower beta typically widen the no-trading zone, while the impact of volatility is ambiguous. View Full-Text
Keywords: optimal portfolio choice; transaction costs; hedging optimal portfolio choice; transaction costs; hedging
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This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited (CC BY 4.0).
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Gallien, F.; Kassibrakis, S.; Malamud, S. Hedge or Rebalance: Optimal Risk Management with Transaction Costs. Risks 2018, 6, 112.

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