Cross Hedging Research Articles

Hedging price risk when real wealth matters

This paper analyzes optimal hedging of a tradable risk (e.g. price risk or exchange rate risk) with forward contracts in the presence of untradable inflation risk. Utility is defined over real wealth. Optimal forward positions are derived relative to a given initial exposure in the tradable risk. A nominally unbiased forward market usually implies a non-zero real risk premium and hence some risk taking. If untradable inflation risk is a monotone function of the tradable risk plus noise, cross hedging and speculating on the real risk premium are conflicting objectives; the level of relative risk aversion determines which objective is dominant in a nominally unbiased forward market.

Exports and hedging exchange rate risks: the multi-country case

This article examines the optimal production, export allocation, and hedging decisions of a risk‐averse international firm that exports to several foreign markets with different currencies. The firm faces multiple exchange rate risks. Optimal decisions are analyzed under two scenarios. In the first, there is a forward market for one currency only. Then, the export allocation to different markets is separable from the firm's preferences and the joint distribution of the exchange rates. In contrast, total production is not separable except for a special case. In the second scenario, there is a forward market for each currency. Then, both production and export allocation are separable. Hedging with forward contracts depends on risk premia and on the joint distribution of the exchange rates. If tradable exchange rate risk is a linear function of untradable exchange rate risk plus noise, there is a conflict between cross hedging and taking a basis risk. If, alternatively, the untradable exchange rate risk is a linear function of the tradable exchange rate risk and noise, there is no such conflict. A speculative position in a biased forward market for one currency can be cross hedged using an unbiased forward market for another currency. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:843–864, 2000.

Dynamic Cross Hedging with Mortgage-Backed Securities

Dynamic Cross Hedging with Mortgage-Backed Securities

Dynamic Cross Hedging with Mortgage-Backed Securities

Hedging the risk of mortgage-backed securities (MBS) has long been a concern of the many institutional owners of these bonds. Recent financial losses have hastened the need to understand how best to deal with the indeterminate timing of cash flows, notably the prepayment option that allows a home buyer to prepay a mortgage at any time. Prepayments affect the duration of MBS. Moreover, rate changes affect bond values differently because bond losses caused by rate increases tend to dwarf bond gains caused by rate drops.

Cross hedging in currency forward markets: A note

Cross hedging in currency forward markets: A note

Exchange Rate Risk, Export and Hedging

In an intertemporal model the impact of exchange rate risk on an international firm is studied under the assumption that no forward markets are existing in the foreign currency. However, there is a forward traded financial asset, whose spot price is highly correlated with the random spot exchange rate, i.e. regressable on it. The direction of regression for spot and futures prices turns out to be important when the effects of cross hedging are analysed. It is shown that the exporting firm underhedges if the futures market is unbiased. Furthermore, it is demonstrated that the separation property does not hold, i.e. export production and financial decisions cannot be separated from expectations and risk behaviour. © 1997 John Wiley & Sons, Ltd.

Improving wholesale beef and pork product cross hedging

This study examines possible causes for the poor performance that has characterized the forward pricing and hedging practices used by participants in meat processing and merchandising operations. Alternative methods of managing price risk or meat merchandisers are presented and evaluated. The empirical analysis suggests pork and beef slaughter firms and merchandisers should seriously consider using more sophisticated cross hedge models to improve upon the poor performance of some forward contracting and hedging programs currently in use. © 1996 John Wiley & Sons, Inc.

Improving wholesale beef and pork product cross hedging

This study examines possible causes for the poor performance that has characterized the forward pricing and hedging practices used by participants in meat processing and merchandising operations. Alternative methods of managing price risk or meat merchandisers are presented and evaluated. The empirical analysis suggests pork and beef slaughter firms and merchandisers should seriously consider using more sophisticated cross hedge models to improve upon the poor performance of some forward contracting and hedging programs currently in use. © 1996 John Wiley & Sons, Inc.

Hedging Risk For Feeder Cattle With A Traditional Hedge Compared To A Ratio Hedge

Abstract This paper compares hedging risk for various weights of feeder cattle hedged with a traditional cross hedge and a ratio cross hedge. A traditional hedge calls for the purchase/sale of one pound of futures for each pound of cash feeder cattle. By contrast, a ratio hedge requires estimation of a hedge ratio to determine the number of pounds of futures needed to hedge one pound of cash feeder cattle. Hedge ratios were found to be larger than 1.0 for light-weight feeder cattle. By using the estimated hedge ratios, it was shown that hedging risk could be reduced 20-50 percent compared to that achieved by using a hedge ratio of 1.0.

CROSS HEDGING AUSTRALIAN CATTLE*

A major part of Australian cattle trade takes place in markets for animals which do not meet the specifications for the trade steer contract. However, producers, processors and marketers of cattle which are nondeliverable on the futures market may be able to make use of the futures market through the process of cross hedging. The aim is to determine whether or not various types of Australian cattle could, in fact, have been cross hedged successfully in the past using the existing Australian cattle futures contracts. Cross hedging is evaluated over time, space and product form to assess the potential for cross hedging that has existed since the Sydney Futures Exchange's cattle contract was first offered for trading. No attempt will be made to identify 'optimal' cross-hedging strategies. The specifications of the trade steer contract have changed over time. When first introduced in July 1975 the contract was labelled 'futures type steers'. Prior to 1 July 1977 the contract called for carcass deliveries. Since that date, live deliveries have been made, hence the references to 'live cattle' contracts in the literature. Due to this change in specifications, data from live delivery markets only were used in this analysis.

Cross Hedging

The paper provides a theoretical description of hedging in futures markets that account for the behavior of a broad class of agents. Specific optimal decision rules are derived for agents concerned with the mean and variance of profit. These rules are used to evaluate how optimal cash and futures positions are related to price expectations, the production possibilities, and the number of futures markets available.