Is it better to grade hedging strategies based on the sum of absolute or squared hedging errors?

Let's say I have one strategy that has a hedging error of:

2, 2, -2, -2

Let's say I have another strategy that has a hedging error of

.5, .5, 3, 3

Would it be a better idea to grade the hedging strategies based on the sum of hedging errors (absolute value) or the sum of squares of hedging errors? Why?

• Both are valid, but in terms of what is "commonly accepted," probably better to go with sum of squares. Sep 22 '11 at 20:29
• Tal, why is the sum of squares used in particular? Why not take the sum of absolute values multiplied by two? I'm not disagreeing with you, I just am trying to understand why using the sum of squares in particular is preferred. Sep 22 '11 at 20:35
• Because risk models are typically evaluated in terms of $R^2$, which corresponds in your case to sum of squared hedging errors. Sep 22 '11 at 21:20