Graduation Year

2023

Date of Submission

4-2023

Document Type

Campus Only Senior Thesis

Degree Name

Bachelor of Arts

Department

Economics

Reader 1

Eric Hughson

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Abstract

This paper examines whether tail risk hedging using put options outperforms a benchmark portfolio over the long run, which I define as 30 years. Using a proprietary model I built from scratch, I run 1,000 simulations for 30 years using randomly generated monthly logarithmic returns based on the following input parameters: SPY’s average monthly return and volatility over the last 30 years. I then compare the returns of two hypothetical portfolios, one is unhedged (100% index) and the other is hedged. For the hedged portfolio, I calculate the cost of European puts using the Black-Scholes option pricing model. I find that, on average, the unhedged portfolio outperforms the hedged portfolio over 30 years. These results suggest that an investor whose goal is to strictly maximize their portfolio’s geometric mean over the long run should not hedge their portfolio’s left tail. However, if an investor’s goal is to minimize their portfolio’s monthly volatility and/or drawdown(s) at the expense of a slightly lower geometric mean, then an investor should hedge their portfolio’s left tail.

This thesis is restricted to the Claremont Colleges current faculty, students, and staff.

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