Hedging Effectiveness Research Articles

Information Asymmetry, Financial Intermediation, and Wealth Effects of Project Finance Loans

Abstract Using a unique hand-collected sample, we study market reactions to mining developers announcing project finance loans. We document a significant three-day abnormal return of 2.6% and a 3.4% reduction in abnormal bid-ask spread around loan approvals, consistent with information transfer from private lenders to equity holders and reduction in asymmetric information. Cross-sectional analysis reveals a negative association between announcement return and hedging requirements specified in loan contracts, which becomes insignificant after controlling for treatment effects of hedging. Specialist banks do not charge lower rates but are more likely to impose hedging requirements, consistent with rent extraction due to bargaining power. (JEL G30, G32)

Risk-adjusted valuation for real option decisions

We model investor heterogeneity using different required returns on an investment and evaluate the impact on the valuation of an investment. By assuming no disagreement on the cash flows, we emphasize how risk preferences in particular, but also the costs of capital, influence a subjective evaluation of the decision to invest now or retain the option to invest in future. We propose a risk-adjusted valuation model to facilitate investors’ subjective decision making, in response to the market valuation of an investment opportunity. The investor’s subjective assessment arises from their perceived misvaluation of the investment by the market, so projected cash flows are discounted using two different rates representing the investor’s and the market’s view. This liberates our model from perfect or imperfect hedging assumptions and instead, we are able to illustrate the hedging effect on the real option value when perceptions of risk premia diverge. During crises periods, delaying an investment becomes more valuable as the idiosyncratic risk of future cash flows increases, but the decision-maker may rush to invest too quickly when the risk level is exceptionally high. Our model verifies features established by classical real-option valuation models and provides many new insights about the importance of modelling divergences in decision-makers risk premia, especially during crisis periods. It also has many practical advantages because it requires no more parameter inputs than basic discounted cash flow approaches, such as the marketed asset disclaimer method, but the outputs are much richer. They allow for complex interactions between cost and revenue uncertainties as well as an easy exploration of the effects of hedgeable and un-hedgeable risks on the real option value. Furthermore, we provide fully-adjustable Python code in which all parameter values can be chosen by the user.

Nexus between Southeast Asian stock markets, bitcoin and gold: spillover effect before and during the COVID-19 pandemic

PurposeThis study aims to provide empirical evidence on the return and volatility spillover effects between Southeast Asian stock markets, bitcoin and gold in the periods before and during the COVID-19 pandemic. The interdependence among different asset classes, the two leading stock markets in Southeast Asia (Singapore and Thailand), bitcoin and gold, is analyzed for diversification opportunities.Design/methodology/approachThe vector autoregressive-Baba, Engle, Kraft, and Kroner-generalized autoregressive conditional heteroskedasticity model is used to capture the return and volatility spillover effects between different financial assets. The data cover the period from October 2013 to May 2021. The full period is divided into two sub-sample periods, the pre-pandemic period and the during-pandemic period, to examine whether the financial turbulence caused by COVID-19 affects the interconnectedness between the assets.FindingsThe stocks in Southeast Asia, bitcoin and gold become more interdependent during the pandemic. During turbulent times, the contagion effect is inevitable regardless of region and asset class. Furthermore, bitcoin does not provide protection for investors in Southeast Asia. The pricing mechanism and technology behind bitcoin are different from common stocks, yet the results indicate the co-movement of bitcoin and the Singaporean and Thai stocks during the crisis. Finally, risk-averse investors should ensure that gold constitutes a significant proportion of their portfolio, approximately 40%–55%. This strategy provides the most effective hedge against risk.Originality/valueThe mean return and volatility spillover is analyzed between bitcoin, gold and two preeminent stock markets in Southeast Asia. Most prior studies test the spillover effect between the same asset classes such as equities in different regions or different commodities, currencies and cryptocurrencies. Moreover, the time-series data are divided into two groups based on the structural break caused by the COVID-19 pandemic. The findings of this study offer practical implications for risk management and portfolio diversification. Diversification opportunities are becoming scarce as different financial assets witness increasing integration.

Understanding the effects of roadside hedges on the horizontal and vertical distributions of air pollutants in street canyons

Built-up environments limit air pollution dispersion in street canyons and lead to complex trade-offs between green infrastructure (GI) usage and its potential to reduce near-road exposure. This study evaluated the effects of an evergreen hedge on the distribution of particulate matter (PM1, PM2.5, PM10), black carbon (BC) and particle number concentrations (PNCs) in a street canyon in West London. Instrumentation was deployed around the hedge at 13 fixed locations to assess the impact of the hedge on vertical and horizontal concentration distributions. Changes in concentrations behind the hedge were measured with reference to the corresponding sampling point in front of the hedge for all sets of measurements. Results showed a significant reduction in vertical concentrations between 1 and 1.7 m height, with maximum reductions of –16% (PM1 and PM10) and –17% (PM2.5) at ∼1 m height. Horizontal concentrations revealed two zones between the building façade and the hedge, with opposite trends: (i) close to hedge (within 0.2 m), where a reduction of PM1 and PM2.5 was observed, possibly due to dilution, deposition and the barrier effect; and (ii) 0.2–3 m from the hedge, showing an increase of 13–37% (PM1) and 7–21% (PM2.5), possibly due to the blockage effect of the building, restricting dispersion. BC showed a significant reduction at breathing height (1.5 m) of between –7 and –50%, followed by –15% for PNCs in the 0.02–1 µm size range. The ELPI + analyser showed a peak of ∼30 nm. The presence of the hedge led to a ∼39 ± 32% decrease in total PNCs (0.006–10 µm), suggesting a greater removal in different modes, such as a 83 ± 12% reduction in nucleation mode (0.006–0.030 µm), 74 ± 15% in ultrafine (≤0.1 µm), and 34 ± 30% in accumulation mode (0.03–0.3 µm). These findings indicate graded filtering of particles by GI in a near-road street canyon environment. This insight will guide the improved design of GI barriers and the validation of microscale dispersion models.

Volatility linkages between stock and commodity markets revisited: Industry perspective and portfolio implications

This study investigates volatility linkages and risk management in stock and commodity markets at the sectoral level. Static and dynamic correlations consistently reveal a high level of co-movement in the stock market, unstable and generally weak dynamic correlations both in commodity sectors and across the two markets. Motivated by the dynamic connectedness, we explore the hedging effectiveness between stock and commodity returns and find that the adopted commodity indices can successively serve as diversifiers to alternative sectors in the US stock market, and vice versa. Furthermore, spillover networks indicate that the volatility spillover effects between the sectoral stock and commodity markets are negligible, whereas strong bidirectional spillover exists for different sectors in the US stock market, which echo the contemporaneous volatility linkages. We also extend our results by employing several representative stock and commodity futures, constructing spillover indices based on the TVP-VAR model, and conducting a wide range of robustness checks.

Hedging Bitcoin with conventional assets

The recent 50% drop in the price of the flagship cryptocurrency Bitcoin reinforces the persistent anxiety among cryptocurrency investors. Can alternative assets hedge Bitcoin risk? This study investigates the ability of equities, commodities, bonds, currencies, and VIX futures to hedge Bitcoin. Our in-sample analysis shows that the USDX, Gilt, Australian dollars, wheat, cocoa, cotton, sugar, copper, and lean hog can hedge Bitcoin, and the out-of-sample analysis reveals that the DAX, Dow-Jones, Nikkei, S&P 500, Brent, and WTI futures can be effective hedging instruments. We use a wavelet-based dynamic hedging model to account for heterogeneous investors in the Bitcoin market. For a short-term horizon, soybean futures reduce the variance in the in-sample hedged portfolio, and cotton futures offer the highest out-of-sample utility. Copper futures are the best for in-sample hedging in a long-term horizon, whereas live cattle futures have the best out-of-sample performance. These results show that conventional assets can hedge wild swings in Bitcoin.

Time-frequency information transmission among financial markets: evidence from implied volatility

In this paper, we utilize the Chicago Board Option Exchange (CBOE) implied volatility indices to estimate the time-frequency information transmission among financial markets from 01.08.2008 to 31.10.2019. In doing so, we utilize the rolling window wavelet correlation (RWWC), Diebold & Yilmaz (The Economic Journal 119: 158–171, 2012), and Barunik & Krehlik (Journal of Financial Econometrics 16: 271–296, 2018). Our empirical findings suggest short-term and long-term dynamic connectedness between implied volatility indices of alternative assets. The long-term analysis findings suggest potential hedging and diversification opportunities that can be exploited by taking offsetting positions across volatility indices. The findings confirm heterogeneity between short-term and long-term connectedness results. Our findings also show superior out of sample hedging effectiveness of GVZ. The implications of the findings are further discussed in the paper.

The impact of price hedging on subsidized insurance: Evidence from Canada

AbstractThis article examines the effect of price hedging on publicly subsidized insurance. Theoretically, the effect of hedging is found to have an ambiguous effect on the incentive to purchase revenue insurance. A simulation is used to analyze the relationship between hedging and the Canadian AgriStability program in three regions in Saskatchewan. AgriStability is a margin insurance product, though in the simulation I hold input use constant, allowing the program to operate as if it were revenue insurance. Hedging is found to substantially reduce enrolment in AgriStability in each region. Furthermore, in some simulations the benefits that producers receive from AgriStability are smaller than the value of government subsidies. The results offer an explanation for low participation in AgriStability and show that the risk‐reducing effect of AgriStability is moderated by the ability of crop producers to hedge price risk through other means.

Tail dependence between bitcoin and green financial assets

The high power consumption of Bitcoin transactions has raised environmental and sustainable concerns of green investors and regulatory bodies. We utilize the time-varying optimal copula (TVOC) approach to showcase the dependence structure between bitcoin and green financial assets. We find multiple tail-dependence regimes characterize the extreme dependence between bitcoin and green financial assets, and the dependence structure is mainly asymmetric and time-varying. Finally, the hedging effectiveness of green financial assets for bitcoin revealed that all green assets, especially clean energy, are effective hedges for bitcoin.

Hedge Effectiveness of the Credit Default Swap Indices: a Spectral Decomposition and Network Topology Analysis

Hedge Effectiveness of the Credit Default Swap Indices: a Spectral Decomposition and Network Topology Analysis

Numerical investigations on turbulent jet ignition with gasoline as an auxiliary fuel in rapid compression machines

ABSTRACT Lean burning as one of the low-temperature combustion strategies has the potential to reduce pollution emissions and improve fuel efficiency. However, highly diluted mixtures cause internal combustion engines to suffer from severe combustion instabilities. Turbulent jet ignition (TJI) technology is considered an effective way to solve these issues, but most previous work mainly considers the passive TJI systems fueled by gaseous fuel. In this work, an active TJI system with gasoline as an auxiliary fuel was investigated using three-dimensional computational fluid dynamics (CFD) simulations in rapid compression machines (RCM). High-pressure low-temperature operating conditions were established to mimic the combustion situation of supercharged spark-ignition engines. Different injection parameters for pre-chamber were considered, including injection timing, injection angle, and injection pulse width, and the influence of injection parameters on the evolution of turbulent jet flame in the main chamber with lean mixtures was investigated. The results show that the hedging effect between reverse squeezed flow and high-speed fuel spray during piston compression promotes gasoline spray atomization, evaporation, and mixing in the pre-chamber. The initial lambda of the pre-chamber plays a significant role in the jet exit velocity, while the initial lambda of the main chamber exhibits a greater impact on the jet propagation distance. Meanwhile, there are generally three stages for the entire combustion in the main chamber, including jet penetration, jet ignition, and spontaneous combustion. The present work can provide useful insights into the optimization and design of active TJI systems in realistic engines.

Optimal futures hedging strategies based on an improved kernel density estimation method.

In this paper, we study the hedging effectiveness of crude oil futures on the basis of the lower partial moments (LPMs). An improved kernel density estimation method is proposed to estimate the optimal hedge ratio. We investigate crude oil price hedging by contributing to the literature in the following twofold: First, unlike the existing studies which focus on univariate kernel density method, we use bivariate kernel density to calculate the estimated LPMs, wherein the two bandwidths of the bivariate kernel density are not limited to the same, which is our main innovation point. According to the criterion of minimizing the mean integrated square error, we derive the conditions that the optimal bandwidths satisfy. In the process of derivation, we make a distribution assumption locally in order to simplify calculation, but this type of local distribution assumption is far better than global distribution assumption used in parameter method theoretically and empirically. Second, in order to meet the requirement of bivariate kernel density for independent random variables, we adopt ARCH models to obtain the independent noises with related to the returns of crude oil spot and futures. Genetic algorithm is used to tune the parameters that maximize quasi-likelihood. Empirical results reveal that, at first, the hedging strategy based on the improved kernel density estimation method is of highly efficiency, and then it achieves better performance than the hedging strategy based on the traditional parametric method. We also compare the risk control effectiveness of static hedge ratio vs. time-varying hedge ratio and find that static hedging has a better performance than time-varying hedging.

Cross hedging with stock index futures

This paper examines the cross hedging effectiveness between UK FTSE100 and world stock index futures from developed and emerging markets: the US, Australia, Brazil, Japan, Hong Kong, Korea and Malaysia. Our daily dataset spans from August 2002 through November 2019. We apply the OLS, VECM and Maximal Overlap Discrete Wavelet Transform (MODWT) to calculate the optimal cross hedge ratio and cross hedging effectiveness. Our empirical results show that the US E-Mini DJIA$5 futures contract is the best cross hedging instrument for the UK FTSE100, followed by the Australia S&P/ASX 200. The multiscale cross hedging effectiveness results from the MODWT estimation suggest the optimal hedging period of more than 256 days with the US E-Mini DJIA$5 and Australia S&P/ASX 200 futures.

The dynamics of carbon on green energy equity investment: quantile-on-quantile and quantile coherency approaches.

We analyze the dynamic correlation between the carbon price and the stock returns of green energy companies and calculate the hedging effect of the carbon price on stock returns in green energy sectors. The results show that the coefficients of the carbon price change with time and are vulnerable to extreme events like the COVID-19. The quantile-on-quantile (QQ) model results reveal a dynamic effect from the carbon price to the stock returns of green energy sectors. The quantile coherency (QC) approach results show that investors can benefit more in the short term with high-frequency trading to hedge between carbon trading and the green energy stock market. What is more, the hedging effects are heterogenetic and investors should adjust their hedging strategies in different quantiles.

Practical Applications of Inflation Hedging in the Long Run: Perspectives from Seven Centuries of Commodity Prices

In <b><i>Inflation Hedging in the Long Run: Perspectives from Seven Centuries of Commodity Prices</i></b>, published in the Summer 2021 issue of <b><i>The Journal of Alternative Investments</i></b>, <b>Adam Zaremba</b> of <b>Montpellier Business School, Jan J. Szczygielski</b> of <b>Kozminski University, Zaghum Umar</b> of <b>Zayed University</b> and <b>Mateusz Mikutowski</b> of <b>Pozna´n University of Economics and Business</b> investigate the efficacy of using commodities to hedge inflation risk. They analyze the relationship between inflation and various commodity price indexes across varying lengths of time and regions. The evaluation includes rolling correlations to see if relationships change over time. Results illustrate that commodities can be very effective hedging tools. However, some commodities do a better job than others. The optimal choice depends on what regions’ or countries’ inflation risk one seeks to mitigate, and the optimal choice can change as conditions change in the future. For example, in many countries, agricultural commodities used to be among the best hedging instruments but have since been displaced by energy commodities. <b>TOPICS:</b>Commodities, global, performance measurement, financial crises and financial market history

Practical Applications of Inflation Hedging in the Long Run: Perspectives from Seven Centuries of Commodity Prices

In <b><i>Inflation Hedging in the Long Run: Perspectives from Seven Centuries of Commodity Prices</i></b>, published in the Summer 2021 issue of <b><i>The Journal of Alternative Investments</i></b>, <b>Adam Zaremba</b> of <b>Montpellier Business School, Jan J. Szczygielski</b> of <b>Kozminski University, Zaghum Umar</b> of <b>Zayed University</b> and <b>Mateusz Mikutowski</b> of <b>Pozna´n University of Economics and Business</b> investigate the efficacy of using commodities to hedge inflation risk. They analyze the relationship between inflation and various commodity price indexes across varying lengths of time and regions. The evaluation includes rolling correlations to see if relationships change over time. Results illustrate that commodities can be very effective hedging tools. However, some commodities do a better job than others. The optimal choice depends on what regions’ or countries’ inflation risk one seeks to mitigate, and the optimal choice can change as conditions change in the future. For example, in many countries, agricultural commodities used to be among the best hedging instruments but have since been displaced by energy commodities.

Hedge effectiveness assesment in non-financial organizations: economic approach

The existing approaches to assessing the effectiveness of risk hedging with derivatives according to various criteria have been considered. As a result it was found that in economic literature it is not paid enough attention to the development of assessment methodology, which take into account the impact of risk hedging on the overall performance of the organization. In this regard, an economic approach to assessing the effectiveness of hedging has been proposed; it is based on the comparison two basic categories of the efficiency theory – the achieved effects and the associated costs. Within the framework of this approach the effects of hedging that affect the overallresult of the organization’s activities were proposed. Also the costs associated with hedging were systematized into external and internal. The essential content of the proposed economic approach is presented in comparison with other approaches, which contributes to understanding the criteria for assessment hedge effectiveness in each specific case. The application of the proposed economic approach in non-financial organizations will contribute to improving the quality of risk hedging by using performance assessment criteria that meet the current goals of the organization and the requirements of senior management.

Spillovers and bivariate portfolios of gold-backed cryptocurrencies and gold during the COVID-19 outbreak

PurposeThis paper aims to analyze the time-varying connectedness of gold-backed cryptocurrencies and gold. This study determines the volatility spillovers in these two asset classes and the performance of bivariate portfolios based on net pairwise spillovers.Design/methodology/approachThis research uses two Islamic and four conventional gold-backed cryptocurrencies and gold as variables. GJR-GARCH method under corrected DCC (cDCC) of Aielli (2013) evaluates the dynamic connectedness. Additionally, the spillovers are created using the dynamic connectedness of Diebold and Yilmaz (2012). A network-based spillover of Diebold and Yılmaz, (2014) is also made. A dynamic optimal weights strategy optimized with DCC-t-Copula determines bivariate portfolios’ performances. In general, there are 21 bivariate portfolios.FindingsThe outbreak of COVID-19 increases the dynamic connectedness of gold and gold-backed cryptocurrencies, which indicates a contagion effect. The results show that gold is the net volatility receiver during the COVID-19 pandemic. Moreover, a portfolio composed of gold and gold-backed cryptocurrency provides high profitability performance but zero hedge effectiveness under optimal weights strategy.Practical implicationsAccording to bivariate portfolios based on net pairwise spillovers, gold-backed cryptocurrencies' investors should not add gold to their portfolio during the pandemic because it is a net receiver of risk from the cryptocurrencies.Originality/valueTo the best of the author’s knowledge, this is the first paper to create bivariate portfolios composed of gold-backed cryptocurrencies and their underlying asset using DCC-t-Copula.

Dynamic diversification benefits of Sukuk and conventional bonds for the financial performance of MENA region companies: empirical evidence from COVID-19 pandemic period

PurposeThis study aims to investigate the spillover between the Middle East and North Africa (MENA) stock index and several security indices, including Sukuk and conventional bond, and ultimately compare the hedge effectiveness of Sukuk and conventional bond.Design/methodology/approachThe study uses VAR (1)-asymmetric Baba, Engle, Kraft and Kroner-multivariate generalized autoregressive conditional heteroskedasticity (1,1) model to analyze the volatility and shock and asymmetric shock spillover between Sukuk index and several bond indices in the MENA region including, Bond, All Bond, High Yield Bond and Bond and Sukuk and MENA stock market index and ultimately compare the hedging capabilities of Sukuk and conventional bonds by calculating the optimal portfolio weights for securities indices and stock portfolios and hedge effectiveness of security indices.FindingsResults indicate that there is no shock, volatility and asymmetric shock spillover between the Sukuk index and MENA stock index, implying that Sukuk indices behave independently from MENA stock indices; however, there is shock and asymmetric shock spillover between MENA stock indices and security indices that include conventional bonds. The result of optimal portfolio weights and corresponding hedge effectiveness indicate that Sukuk is the most significant asset among other security indices in diversifying and hedging stock MENA portfolios. Moreover, the hedge effectiveness of Sukuk shows persistent trends during both the normal and crisis periods.Practical implicationsThe study suggests that MENA stock market investors and investment managers should add Sukuk instead of the conventional bond to their portfolio to hedge their portfolio against investment risks during both normal and crisis periods.Originality/valueAlthough many studies compare many aspects of Sukuk and conventional bonds, this is the first study that compares the hedge effectiveness of Sukuk and conventional bond based on the time-varying optimal portfolio weights strategy.

Volatility Spillovers between Stock and Energy Markets during Crises: A Comparative Assessment between the 2008 Global Financial Crisis and the Covid-19 Pandemic Crisis

This paper investigates volatility spillovers between energy and stock markets during periods of crises. Our main findings reveal that transmissions of volatilities among these markets during the Covid-19 pandemic crisis exceeded the ones recorded throughout the 2008 global financial crisis. All stock markets are net transmitters of volatility to energy markets during the 2008 global financial crisis while they show different patterns during the Covid-19 crisis. We also provide evidence of asymmetric volatility spillovers among stock and energy markets. Our results also indicate that on average natural gas provides better hedging effectiveness to the stock markets than crude oil.