Downside-risk hedging by Quantile-specification

This paper addresses the hedging problem of an excess exposure to domestic markets, and uses a foreign market as a hedging instrument. Conventionally hedging concerns minimum variance portfolios, though this paper mainly focuses on hedging downside –risk. Linear Quantile Regressions and Normal- and Student T-copula quantiles are specified to find quantile specific (downside) optimal hedge ratios. By simulation these methods are used to estimate optimal hedge-ratios during several years and performance is measured. This paper concludes OLS-based minimum variance hedges outperform downside-risk hedges on both variance reduction and portfolio’s value lost at extreme downside deviations.