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Explanation:
In the context of hedging portfolios using OLS regression techniques, a regression hedge determines the optimal hedge ratio (the risk weight) using the regression beta of the portfolio's value changes against the hedging instrument's value changes. Conversely, a reverse regression runs the instrument's changes against the portfolio's changes, producing a beta that leads to an inversely adjusted hedge ratio structure. Because is typically less than 1, the hedge ratios from the standard regression and reverse regression will differ, adjusting the risk weights inversely.
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Q.11 In the context of hedging portfolios using regression techniques, how does the approach to managing risk vary between a typical regression hedge and a reverse regression hedge?
A
Regression hedge diminishes risk weight by undersampling yields, reverse regression has no effect on risk weight.
B
Regression supports allocating risk weight based on regression beta; reverse regression inversely adjusts risk weight.
C
Both regression hedge and reverse regression hedge distribute risk weight proportionately alike.
D
Regression hedge implies preserving all prior risk exposures, whereas reverse regression modifies them completely.