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Explanation:
In fixed income hedging using regression techniques, a typical regression hedge calculates the hedge ratio (and allocates risk weight) based on the beta coefficient derived from regressing the dependent variable (the asset to be hedged) against the independent variable (the hedging instrument).
Conversely, a reverse regression involves regressing the independent variable on the dependent variable. In this setup, the hedge ratio and the resulting risk weight adjustment are based on the inverse of the reverse regression coefficient. Thus, regression directly utilizes the beta for risk weighting, while reverse regression inversely adjusts the risk weight.
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.
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