Hedging is an important topic in portfolio and risk management; however, relatively little research has been conducted in this area. Many questions remain open, such as when to hedge, how frequently to hedge, and which volatility measure should be used in hedging decisions.
We have previously discussed whether hedging should rely on historical volatility or implied volatility. Reference [1] extends this line of inquiry by comparing the performance of hedging strategies based on historical versus implied volatility using S&P500 index ETF options.
The authors pointed out,
We experimentally show that the degree to which IV and HV hedging are effective as hedge depends on the context of the market. For calmer periods, our result shows that using HV-based delta hedge is still effective, with lower tracking error and transaction cost, which implies that backward looking of HV is somewhat beneficial when the speed at which volatility dynamics change is slow. On the other hand, in times of high volatility and due to structural breaks the IV-based rules perform better as options capture forward looking information. The asymmetric role of regimes highlights the relevance of regime adaptive hedging systems for SPY/S&P 500 options…
Although our results go in line with most of the literature in the topic, they give indications which deserve a deeper analysis. For instance, we observe a tendency for the relative performance disadvantage of IV- and HV-based approaches to become larger in presence of volatility clustering,indicating that hybrid models which combine the robustness of HV and the foresight of IV might lead to even better hedging results. In addition, transaction costs (especially for high frequency rebalancing) can significantly change the relative net advantage of one strategy versus another.
In short, the article finds that implied volatility reacts faster and captures short-term risks more effectively but performs worse in stable markets, while historical volatility delivers lower tracking errors in calm conditions, suggesting that the choice—and potential combination—of IV and HV should depend on market regimes.
We find the results valuable and the research direction worth pursuing. However, as with the previous article, the data sample size is relatively small, although the findings are intuitively consistent.
Let us know what you think in the comments below or in the discussion forum.
References
[1] Haocheng Yang, Hedging Effectiveness of Implied Volatility vs Historical Volatility, Proceedings of ICFTBA 2025 Symposium: Global Trends in Green Financial Innovation and Technology
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