Reducing Volatility with Financial Futures

Abstract

Hedging with financial and currency futures contracts can substantially reduce fluctuations in the value of foreign currency, corporate bond, GNMA security and equity positions. The authors tested hedges involving a spot position in corporate bonds and a position in GNMA or U. S. Treasury bond futures; a futures and a spot position in GNMAs; a futures and a spot position in each of five broadly traded foreign currencies; and a futures aznd a spot position in the Value Line Index, the S&P 500 and the NYSE composite. In all cases, hedged positions proved significantly less risky, in terms of standard deviation, than unhedged positions. Use of the interest rate futures to hedge long-term bond positions resulted in 50 per cent reductions in the variability of spot price changes. Hedging reduced the risk of all but one of the foreign currencies and all of the stock market indexes by over 40 per cent.