Tail Risk Hedging: The Superiority of the Naïve Hedging Strategy

Abstract

Mitigating extreme tail risk is essential for institutions and corporations to prevent financial losses from severe asset price fluctuations across many asset classes. This study shows that a simple futures hedging strategy, the naïve hedge, is remarkably effective at managing tail risk—so much so that few other methods can beat it. Notably, the naïve hedge demonstrates significant outperformance during periods of below-average economic growth, offering insights into its practical applications. Furthermore, we highlight the role of estimation error in explaining our findings, providing a clear rationale for the success of simpler strategies. This study provides a challenge to complex conventional approaches and provides a simple, difficult-to-beat benchmark for financial practitioners using futures to reduce tail risk in volatile financial markets.