This paper investigates the hedging effectiveness of a dynamic moving window
OLS hedging model, formed using wavelet decomposed time-series. The wavelet
transform is applied to calculate the appropriate dynamic minimum-variance
hedge ratio for various hedging horizons for a number of assets. The
effectiveness of the dynamic multiscale hedging strategy is then tested, both
in- and out-of-sample, using standard variance reduction and expanded to
include a downside risk metric, the time horizon dependent Value-at-Risk.
Measured using variance reduction, the effectiveness converges to one at longer
scales, while a measure of VaR reduction indicates a portion of residual risk
remains at all scales. Analysis of the hedge portfolio distributions indicate
that this unhedged tail risk is related to excess portfolio kurtosis found at
all scales.Comment: To Appear: Journal of Futures Market
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