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Dynamic Index Tracking and Risk Exposure Control Using Derivatives

Dynamic Index Tracking and Risk Exposure Control Using Derivatives We develop a methodology for index tracking and risk exposure control using financial derivatives. Under a continuous-time diffusion framework for price evolution, we present a pathwise approach to construct dynamic portfolios of derivatives in order to gain exposure to an index and/or market factors that may be not directly tradable. Among our results, we establish a general tracking condition that relates the portfolio drift to the desired exposure coefficients under any given model. We also derive a slippage process that reveals how the portfolio return deviates from the targeted return. In our multi-factor setting, the portfolio’s realized slippage depends not only on the realized variance of the index but also the realized covariance among the index and factors. We implement our trading strategies under a number of models, and compare the tracking strategies and performances when using different derivatives, such as futures and options. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Applied Mathematical Finance Taylor & Francis

Dynamic Index Tracking and Risk Exposure Control Using Derivatives

Leung, Tim; Ward, Brian
Applied Mathematical Finance , Volume 25 (2): 33 – Mar 4, 2018
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Dynamic Index Tracking and Risk Exposure Control Using Derivatives

Abstract

We develop a methodology for index tracking and risk exposure control using financial derivatives. Under a continuous-time diffusion framework for price evolution, we present a pathwise approach to construct dynamic portfolios of derivatives in order to gain exposure to an index and/or market factors that may be not directly tradable. Among our results, we establish a general tracking condition that relates the portfolio drift to the desired exposure coefficients under any given model. We...
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Publisher
Taylor & Francis
Copyright
© 2018 Informa UK Limited, trading as Taylor & Francis Group
ISSN
1466-4313
eISSN
1350-486X
DOI
10.1080/1350486X.2018.1507750
Publisher site
See Article on Publisher Site

Abstract

We develop a methodology for index tracking and risk exposure control using financial derivatives. Under a continuous-time diffusion framework for price evolution, we present a pathwise approach to construct dynamic portfolios of derivatives in order to gain exposure to an index and/or market factors that may be not directly tradable. Among our results, we establish a general tracking condition that relates the portfolio drift to the desired exposure coefficients under any given model. We also derive a slippage process that reveals how the portfolio return deviates from the targeted return. In our multi-factor setting, the portfolio’s realized slippage depends not only on the realized variance of the index but also the realized covariance among the index and factors. We implement our trading strategies under a number of models, and compare the tracking strategies and performances when using different derivatives, such as futures and options.

Journal

Applied Mathematical Finance – Taylor & Francis

Published: Mar 4, 2018

Keywords: Slippage; index tracking; exposure control; realized covariance; derivatives trading

References

  • A Parametric Nonlinear Model of Term Structure Dynamics
  • Hedging Index Exchange Traded Funds
  • Volatility Exchange-Traded Notes: Curse or Cure?
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  • Path-Dependence of Leveraged ETF Returns
  • Equity Index Replication with Standard and Robust Regression Estimators
  • Studies of Stock Price Volatility Changes
  • The Pricing of Options and Corporate Liabilities
  • A Theory of the Term Structure of Interest Rates
  • Are VIX Futures ETPs Effective Hedges?
  • A Yield-Factor Model of Interest Rates
  • Index-Tracking Optimal Portfolio Selection
  • Two Singular Diffusion Problems
  • Valuing Futures and Options on Volatility
  • A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options
  • The VXX ETN and Volatility Exposure
  • Understand the Risks of Leveraged ETFs
  • Leveraged ETF Implied Volatilities from ETF Dynamics
  • Implied Volatility of Leveraged ETF Options
  • The Golden Target: Analyzing the Tracking Performance of Leveraged Gold ETFs
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  • Valuation of VIX Derivatives
  • A Stochastic Receding Horizon Control Approach to Constrained Index Tracking
  • Trading Volatility: At What Cost?
  • Tracking a Financial Benchmark Using a Few Assets