Cross-hedging Strategies Research Articles

Comparative analysis of futures contract cross-hedging effectiveness for soybean: models and insights

ABSTRACT The purpose of this research is to investigate the use of cross-hedging in the South African soybean market, by using the JSE BEAN contract as a cross-hedge instrument for the JSE SOYA contract. The research study involves a detailed assessment of the data, which includes the use of stationarity tests such as the Phillips-Perron and Augmented Dickey-Fuller, as well as the Johansen co-integration approach to analyse long-term relationships between the variables. To evaluate the efficiency of cross-hedging strategies, three distinct hedging models are used: the ordinary least squares (OLS) model, error correction model (ECM) and EC-GARCH. The results demonstrate that these models produce significant hedge ratios. Through back-testing and the application of hedging strategies, it is determined that the JSE BEAN contract holds the potential to serve as a cross-hedge for the JSE SOYA contract in the South African soybean market. This study provides useful information for market participants and model selection in the context of cross-hedging.

Cross-Hedging Strategies between CDS Spreads and Option Volatility during Crises

Cross-Hedging Strategies between CDS Spreads and Option Volatility during Crises

Is cross-hedging an effective strategy in equity futures market?

This paper aims to evaluate whether the cross-hedging strategy with Nifty 50 and single stock futures is an effective tool to hedge the price risk of single stock investors. The risk reduction potential of different hedge portfolios derived from the optimal hedge ratios is evaluated using the Diagonal BEKK GARCH model. The results reveal that cross-hedging is an effective risk reduction strategy for investors exposed to specific securities devoid of futures. Investors can construct cross-hedging portfolios with futures having closely matching return profiles and hold these positions for a longer trade horizon to achieve higher risk reduction.

Feed price risk management for sheep production in Spain: a composite future cross-hedging strategy

Feed price risk management for sheep production in Spain: a composite future cross-hedging strategy

Hedging of Variable Annuities under Basis Risk

Abstract I study dynamic hedging for variable annuities under basis risk. Basis risk, which arises from the imperfect correlation between the underlying fund and the proxy asset used for hedging, has a highly negative impact on the hedging performance. In this paper, I model the financial market based on correlated geometric Brownian motions and analyze the risk management for a pool of stylized GMAB contracts. I investigate whether the choice of a suitable hedging strategy can help to reduce the risk for the insurance company. Comparing several cross-hedging strategies, I observe very similar hedging performances. Particularly, I find that well-established but complex strategies from mathematical finance do not outperform simple and naive approaches in the context studied. Diversification, however, could help to reduce the adverse impact of basis risk.

Hedging of Variable Annuities under Basis Risk

I study dynamic hedging for variable annuities under basis risk. Basis risk, which arises from the imperfect correlation between the underlying fund and the proxy asset used for hedging, has a highly negative impact on the hedging performance. I investigate whether the choice of a suitable hedging strategy can help to reduce the risk for the insurance company. Comparing several cross-hedging strategies that only trade in the proxy asset, I observe very similar hedging performances. Particularly, I find that well-established but complex strategies from mathematical finance do not outperform simple and naive approaches. Nonetheless, a naive delta-gamma hedge, which additionally uses plain vanilla options on the proxy asset, performs better than all tested one-instrument strategies. A more substantial risk reduction could, however, be achieved by diversification.

Mercados de futuros y físicos de petróleo: transmisión de media y volatilidad

<p>Este trabajo propone el modelo VEC-EGARCH bivariado con correlaciones constantes<br />para analizar el proceso de transmisión de la media y volatilidad entre mercados de<br />futuros de crudo y mercados físicos del petróleo mexicano. Los resultados revelan la<br />existencia de patrones de transmisión de información de rendimientos bilaterales con<br />efectos más fuertes de los mercados de futuros hacia los mercados físicos. En tanto<br />que la evidencia de efectos de transmisión de volatilidad bilateral, sólo existe entre los mercados de futuros y el mercado físico del petróleo Olmeca. Los hallazgos empíricos son relevantes para las autoridades gubernamentales y consumidores porque coadyuvan en el diseño de estrategias de cobertura cruzada, que mitigan la exposición al riesgo de precios en el petróleo mexicano.</p>

Correlation asymmetry and implication on hedging

The paper studies the correlation asymmetry between currency spot and futures returns and its implication on hedging effectiveness using alternative multivariate GARCH models and different hedging strategies. For this purpose, daily data of EUR spot and futures returns are used to present a direct hedging strategy. A cross hedging strategy is also proposed using TND spot and EUR futures returns. Dynamic hedging is implemented using five multivariate GARCH models. The diagonal VECH and BEKK models are chosen among the covariance models. The CC-GARCH, DCC and GDCC represent the correlation models. The empirical results show that correlation between EUR spot and futures returns as well as between TND spot and EUR futures returns exhibit asymmetric behaviour. Moreover, the asymmetric diagonal VECH gives the best performance in terms of portfolio risk reduction in both strategies showing that covariance models are better than correlation models in modelling correlation asymmetry.

Correlation asymmetry and implication on hedging

The paper studies the correlation asymmetry between currency spot and futures returns and its implication on hedging effectiveness using alternative multivariate GARCH models and different hedging strategies. For this purpose, daily data of EUR spot and futures returns are used to present a direct hedging strategy. A cross hedging strategy is also proposed using TND spot and EUR futures returns. Dynamic hedging is implemented using five multivariate GARCH models. The diagonal VECH and BEKK models are chosen among the covariance models. The CC-GARCH, DCC and GDCC represent the correlation models. The empirical results show that correlation between EUR spot and futures returns as well as between TND spot and EUR futures returns exhibit asymmetric behaviour. Moreover, the asymmetric diagonal VECH gives the best performance in terms of portfolio risk reduction in both strategies showing that covariance models are better than correlation models in modelling correlation asymmetry.

Hedging foreign exchange rate risk: Multi-currency diversification

This article proposes a multi-currency cross-hedging strategy that minimizes the exchange risk. The use of derivatives in small and medium-sized enterprises (SMEs) is not common but, despite its complexity, can be interesting for those with international activities. In particular, the reduction in the exchange risk borne through the use of natural multi-currency cross-hedging is measured, considering Conditional Value-at-Risk (CVaR) and Value-at-Risk (VaR) for measuring market risk instead of the variance. CVaR is minimized using linear programmes, while a multiobjective genetic algorithm is designed for minimizing VaR, considering two scenarios for each currency. The results obtained show that the optimal hedge strategy that minimizes VaR is different from the minimum CVaR hedge strategy. A very interesting point is that, just by investing in other currencies, a significant risk reduction in VaR and CVaR can be obtained.

Applications of weather derivatives in the energy market

Abstract: This paper analyzes various types of weather related risks in di erent industries. Sincethe existence and popularity of the established weather insurance market, we also discuss the di er-ences between weather derivatives and insurances and the advantages of using weather derivativesinstead of insurances in weather risk management. For the applications of the temperature futures, rstly, we gave out a static, simple strategy example to hedge the volume risks in practical. Then,by building up a system of models for energy and temperature, we proposed a dynamic hedgingstrategy for the hedge of the energy futures using temperature futures.Keywords: Weather derivatives; Mean-reverting process; Energy market; Dynamic hedging 1 Introduction Weather, especially temperature, risks have signi cant impacts on the operational and nancialdecisions and revenues of various industries, such as energy producers, distributors and retailers.According to the present situation of the notably increasing occurrence of extreme weather andextreme temperature volatility at high latitudes, weather is a ecting the supply and demand inbusiness more gravely. Under this circumstance, hedging strategies and weather derivatives thatcan be deployed to transfer these risk exposures to willing counter parties become increasinglyvaluable and useful. As an application of weather derivative to other commodities markets, theprimary objective of this paper is to consider the cross hedging strategy with other commoditiesusing weather future contracts.

Cross-Hedging Strategies between CDS Spreads and Option Volatility during Crises

Cross-Hedging Strategies between CDS Spreads and Option Volatility during Crises

Credit Spreads and Equity Volatility during Periods of Financial Turmoil

We present a joint analysis of the term structure of credit default swap (CDS) spreads and the implied volatility surface for the United States and five European countries from 2007– 2012, a sample period covering both the Global Financial Crisis (GFC) and the European debt crisis. We analyze to which extent effective cross-hedges can be performed between the CDS and equity derivatives markets during these two crises. We find that during a global crisis a breakdown of the relationship between credit risk and equity volatility may occur, jeopardizing any cross-hedging strategy, which happened during the GFC. This stands in sharp contrast to the more localized European debt crisis, during which this fundamental relationship was preserved despite turbulent market conditions for both the CDS and volatility markets.

Cross-hedging strategies between CDS spreads and option volatility during crises

This paper presents a joint analysis of the term structure of credit default swap (CDS) spreads and the implied volatility surface for five European countries from 2007 to 2012, a sample period covering both the Global Financial Crisis (GFC) and the European debt crisis. We analyze to which extent effective cross-hedges can be performed between the credit and equity derivatives markets during these two crises. We find that during a global crisis a breakdown of the relationship between credit risk and equity volatility may occur, jeopardizing any cross-hedging strategy, which happened during the GFC. This stands in sharp contrast to the more localized European debt crisis, during which this fundamental relationship was preserved despite turbulent market conditions for both the CDS and volatility markets.

Cross-Hedging with Currency Options and Futures

This paper develops an expected utility model of a multinational firm facing exchange rate risk exposure to a foreign currency cash flow. Currency derivative markets do not exist between the domestic and foreign currencies. There are, however, currency futures and options markets between the domestic currency and a third currency to which the firm has access. Since a triangular parity condition holds among these three currencies, the available, yet incomplete, currency futures and options markets still provide a useful avenue for the firm to indirectly hedge against its foreign exchange risk exposure. This paper offers analytical insights into the optimal cross-hedging strategies of the firm. In particular, the results show the optimality of using options in conjunction with futures in the case of currency mismatching, even though cash flows appear to be linear.

Hedging with futures contracts in the Brazilian soybean complex: : BM&F vs. CBOT

This article analyzes the effectiveness of hedging Brazilian soy oil, soy meal, and soybeans in the Chicago Board of Trade (CBOT) and in the Brazilian Commodities and Futures Exchange (BM&F) to reduce the risk of financial loss due to commodity price fluctuations. The econometric results show that a cross-hedging strategy using the BM&F soybean futures contract is an instrument of low effectiveness for managing soy oil and soy meal price risk. Despite low effectiveness, the estimates demonstrate total advantage for soy meal hedging operations using CBOT soy meal futures contracts rather than cross-hedging using BM&F soybean futures contracts. With some exceptions, the results are also more favorable for hedging soy oil with soy oil futures contracts at the CBOT rather than cross hedging with soybeans at the BM&F. Conversely, Brazilian traders hedging soybeans receive more effective risk protection by trading soybean futures contracts at the BM&F than by trading soybean futures contracts at the CBOT.

Cross-hedging with Currency Options and Futures

This paper develops an expected utility model of a multinational firm facing exchange rate risk exposure to a foreign currency cash flow. Currency derivative markets do not exist between the domestic and foreign currencies. There are, however, currency futures and options markets between the domestic currency and a third currency to which the firm has access. Since a triangular parity condition holds among these three currencies, the available, yet incomplete, currency futures and options markets still provide a useful avenue for the firm to indirectly hedge against its foreign exchange risk exposure. This paper offers analytical insights into the optimal cross-hedging strategies of the firm. In particular, the results show the optimality of using options in conjunction with futures in the case of currency mismatching, even though cash flows appear to be linear.

Hedging with futures contracts in a deregulated electricity industry

This paper is a statistical study of direct and cross hedging strategies using futures contracts in an electricity market. A comparison of the strategies is based on the standard deviation or risk of the values of the hedging positions. Results indicate that the use of electricity futures contracts is superior to using other related futures contracts such as crude oil.

Hedging with Futures Contracts in a Deregulated Electricity Industry

This paper is a statistical study of direct and cross hedging strategies using futures contracts in an electricity market. A comparison of the strategies is based on the standard deviation or risk of the values of the hedging positions. Results indicate that the use of electricity futures contracts is superior to using other related futures contracts such as crude oil.

Go Ahead, Count Your Chickens: Cross-Hedging Strategies in the Broiler Industry

AbstractSome suppliers of broilers without giblets (WOG) offer customers a choice between paying Urner Barry's WOG quote or a formula price based on futures prices. From a buyer's perspective, the formula price examined in this study is second-degree stochastic dominant. The formula price allows the seller to set perfect cross-hedges of WOGs with corn and soymeal. Stochastic dominance and mean variance results suggested that the seller's dominant strategy would shift from the Urner Barry quote to the hedged formula price as risk aversion increased. Input-based formula pricing may be usefully extended to other industries.