Minimum-Variance Futures Hedging Under Alternative Return Specifications

• Main Authors: Chu-Yu You, 游儲宇
• Other Authors: Ming-Chi Lee
• Format: Others
• Language: zh-TW
• Published: 2004
• Online Access: http://ndltd.ncl.edu.tw/handle/43944350255303298943

碩士 === 淡江大學 === 財務金融學系碩士班 === 94 === It is widely known that the variance-minimizing futures hedge is given by the ratio of the conditional covariance of the futures and spot returns to the conditional variance of the futures return. This standard result can be found in virtually every leading derivatives or risk management textbook. There is, however, much confusion over the conditions under which this result holds. This result has been asserted either explicitly or implicitly when returns are measured in dollar terms. In this article, we examine the minimum-variance hedge ratio (MVHR) under alternative return specifications. Formulas for the MVHR are derived for cases in which returns are measured in dollar terms, percentage terms, and log terms.. It is found that the conventional hedge ratio given by the ratio of the conditional covariance of the futures and spot returns to the conditional variance of the futures return is variance-minimizing when computed from returns measured in dollar terms but not from returns measured in percentage or log terms. the MVHR can vary significantly from the conventional hedge ratio computed from percentage or log returns when used in cross-hedging situations. Simulation analysis shows that the incorrect application of the conventional hedge ratio can substantially reduce hedging performance in cross-hedging situations.