Hedging strategies for multi-period portfolio optimization

Abstract. This paper develops a multi-period portfolio optimization model that utilizes hedging decisions in a dynamic setting. In this regard, a portfolio of options and underlying stocks is constructed and dierent time-varying Greek letters are utilized to mitigate the market risk. The presented model considers rebalancing decisions during the planning horizon. It assumes an investor is aiming to maximize his/her wealth at the end of the planning horizon, while controlling the investorʹs regret during the planning horizon. The uncertainty of asset prices is represented in terms of a scenario tree. In addition, a scenario generation method is presented that characterizes the temporal correlations and dependence structure of asset returns. Also, it preserves marginal distributions of asset returns. To investigate the eect of hedging strategies, we rst implement the scenario generation method on a set of stocks selected from the New York Stock Exchange (NYSE). Numerical results show the high performance of the scenario generation method. Then, the multiperiod portfolio optimization model is implemented via the generated scenario tree. Results show that incorporation of options remarkably reduces investor risk. Finally, dierent hedging strategies are assessed by imposing bounds on the values of Greek letters and a discussion about numerical results is presented.