Hedging downside risk for REITs

• The paper makes the first attempt to examine downside risk hedging for REITs. • We consider a variety of downside risk measures and assess the hedging performance of minimum-downside-risk (MDR) strategies relative to the benchmark minimum-variance (MV) approach. • The benchmark MV approach is found to lead to under-hedging compared with various MDR approaches. • A simpler historical simulation method generally outperforms the more complex Monte Carlo simulation method in estimating optimal hedge ratios. • A decent amount of tail risk would still remain even after hedging whereas other types of down risk can be largely hedged away. Moreover, as the hedger becomes more concerned with tail risk, the hedging performance would deteriorate. As an alternative investment class, REITs possess a unique ‘duality’ feature and have been experiencing strong downside movements recently. The paper aims to investigate a timely research subject on hedging downside risk for REITs. We consider a variety of downside risk measures and assess the hedging performance of minimum-downside-risk (MDR) strategies relative to the benchmark minimum-variance (MV) approach. Our study reveals two important findings that are distinctive from those reported in other markets: first, the MV approach leads to under-hedging compared with various MDR approaches. Second, a simpler historical simulation method generally outperforms the more complex Monte Carlo simulation method in estimating optimal hedge ratios. Our study also yields similar results as in other markets. We find that a decent amount of tail risk would still remain even after hedging whereas other types of down risk can be largely hedged away. Moreover, as the hedger becomes more concerned with tail risk, the hedging performance would deteriorate.