Measuring the Hedge Ratio

Abstract

Hedging is an attempt to reduce the risk of adverse price changes, such as the exchange rate implicit in a spot position on a currency. Financial hedging, as we have seen, entails taking an offsetting position on another asset or a hedging instrument (say, a forward position on the same or another currency, with the latter constituting cross hedging). The position must be offsetting in the sense that if the unhedged position is long (say receivables) then the position on the hedging instrument must be short, and vice versa. The idea is that if a loss is incurred on the unhedged position, it will be offset by profit on the position in the hedging instrument, and vice versa. Among others, two important questions are involved in the hedging operation: (i) to hedge or not to hedge; and (ii) if the decision to hedge is taken, should the full position be hedged?KeywordsLoss AversionError Correction ModelBase CurrencyError Correction TermSpot PositionThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.