Hedging Tool Research Articles

Sovereign credit default swaps: Managing risks when the fiscal house rumbles

This paper seeks to dissect risks which stem from the features of a sovereign credit default swap under the architecture of the 2014 ISDA Credit Derivatives Definitions (the 2014 Definitions). The paper begins with an overview of the market structure and functions of a sovereign credit default swap, followed by a brief discussion of the landscape behind the product. It then provides a narrative on specific risk considerations, mapped under broad themes such as the Credit Derivatives Physical Settlement Matrix (the Matrix) terms published by the International Swaps and Derivatives Association, Inc. ( ISDA) (including trigger obligations, deliverable obligations, credit events and settlement risk). Examples of Credit Derivatives Determinations Committee (DC) deliberations have been drawn in to elucidate aspects of how the product terms are applied in practice. The goal of the paper is to assist practitioners, infrastructure providers, risk managers, regulators, academics, sovereign issuers and creditors to identify risks and assess the efficiency of sovereign credit default swaps (SOVCDS) as a hedging tool. Due to the vastness of the subject, the paper focuses on SOVCDS traded as a `Standard` transaction type (TType) under the Matrix, where a DC credit event announcement crystallises settlement obligations.

How media coverage news and global uncertainties drive forecast of cryptocurrencies returns?

This paper aims to investigate the impact of global financial, economic, and gold price uncertainty indices (VIX, EPU, and GVZ) and investor sentiment based on media coverage news on the returns of Bitcoin and Ethereum during the COVID-19 pandemic. We adopt an asymmetric framework based on the Quantile-on-Quantile approach, which examines the quantiles of the cryptocurrency returns, investor sentiment, and the various uncertainties indicators. The empirical findings suggest that the COVID-19 pandemic has significantly impacted cryptocurrency returns. Specifically, (i) the results demonstrate the predictive power of Economic Policy Uncertainty (EPU) during this period, as evidenced by a strong negative association between EPU and cryptocurrency returns across all quantiles; (ii) the correlation between cryptocurrency returns and the VIX index was negative but weak, across various quantile combinations of Ethereum and Bitcoin returns; (iii) an increase in COVID-19 news negatively affected Bitcoin returns across all quantiles; (iv) Bitcoin and Ethereum cannot be relied upon as effective hedging tools against global financial and economic uncertainty during the COVID-19 pandemic. Studying the behavior of cryptocurrency during uncertainty like pandemics is extremely important because it provides investors with insights on diversifying their portfolios and hedging their risks.

Optimal bond holding dynamics with hedging against real exchange rate risks

This study examines optimal bond holding dynamics using a two-country DSGE model with two bonds. Unlike previous studies focusing on steady-state properties of optimal bond holdings, we solve the model by employing a third-order approximation method and show how optimal bond holdings respond when macro fundamentals change. In particular, we derive impulse responses of optimal home and foreign bond holdings to productivity shocks. Simulation results show that with a positive productivity shock at home, optimizing home agents decrease holdings of home bonds and increase holdings of foreign bonds. Correlation between relative price and excess bond returns following a positive productivity shock makes home (foreign) bond a less (more) attractive hedging tool against real exchange rate risks. In addition, we use a SVAR method and verify that the optimal bond holding dynamics derived from the model are observed in the data.

Implementing Contract-for-Difference Arrangements for Hedging Electricity Price Risks of Renewable Generators on a Blockchain Marketplace

The dynamic nature of competitive electricity markets means that participants often resort to some form of derivative financial instrument. One such instrument is a contract-for-difference (CFD), usually available to renewable generators in certain electricity markets to enable them to hedge their price risk. Embracing CFD presents new risks such as counterparty credit, margining, third-party, legal, and process risks. Derivative instruments existing on blockchains have recently demonstrated potential as suitable hedging tools for minimizing the risks of renewable generators. This article applies this concept for the first time to hedge the price risk of renewable generators by implementing a novel decentralized finance instrument, an Ethereum blockchain marketplace governed by a smart contract to mediate between stakeholders mutually enrolled in bilateral CFD arrangements. The employed structure mitigates the underlying risks of traditional arrangements, underpinned by a suite of autonomous mechanisms.

Uncovering risk transmission between socially responsible investments, alternative energy investments and the implied volatility of major commodities

The interconnectedness and high integration among the global markets have reduced the portfolio diversification opportunities of international investors. In view of this, considering the rise of Socially Responsible Investments (SRI) and the Clean-Renewable energy & Clean-Technology energy (C&RTE) asset classes, the objective of this research is to examine risk transmission and the portfolio diversification prospects across the SRI, C&RTE, and the implied volatility indices (VIX) of major commodities (oil, silver, and the gold). To uncover the spillover and the risk transmission, we employ the approach of Dynamic conditional correlation (DCC-GARCH) along with the Asymmetric DCC-GARCH and VAR-GARCH. The findings exhibit a strong ability of volatility indices to hedge risks associated with SRIs and C&RTE investments as asymmetric-GARCH confirms that volatility indices have a negative correlation with most of the socially responsible and clean energy and technology equity indices. The findings confirm that the implied volatility indices of gold and silver exhibit the best hedging tool against SRIs while oil is the best hedging tool for C&RTE. During Covid-19, generally oil price volatility index is positively correlated with SRI indices whereas the silver and the gold volatility indices are negatively correlated with the C&RTE. More importantly, we find that hedging effectiveness and risk diversification are facilitated by the adaptive behavior of commodities, confirmed by the Adaptive Market Hypothesis (AMH) through the Generalized Spectral (GS) test. Moreover, we also find some evidence of a time-varying pattern in the hedging ratio and the hedging effectiveness. Finally, we show utility gains from hedging to be positive irrespective of whether we consider transaction costs or not. The findings of the study could be helpful for portfolio managers, brokers, and market participants to draw the role of implied volatilities of commodities in hedging the risk associated with SRIs and C&RTE investments.

COVID-19 and information flow between cryptocurrencies, and conventional financial assets

In this paper, we analyze the impact of the ongoing COVID-19 pandemic on the information flow among the main cryptocurrencies (Bitcoin, Ethereum, Ripple, and Litecoin) and those of the fear index (VIX), Gold price, and the US equity market (S&P500). We use the transfer entropy measure to determine the information flow by allowing for nonlinear dynamics and extreme tail values in the series. Our results indicate that information flow and sharing have changed during the COVID-19 pandemic with the following main findings: i) cryptocurrencies show more correlation with VIX, Gold, and the US equity markets during the COVID-19 period; ii) Gold and VIX maintain their position as safe hedging tools against the pandemic; iii) during COVID-19, S&P500 is the dominant flow transmitter to the four cryptocurrencies, and iv) Ripple plays the dominant role of information flow to VIX, Gold, and S&P500.

Research on Hedging and Risk Management of Stock Index Futures

Futures are a relatively new financial instrument in modern times and play a pivotal role in the economy. Stock index futures, as a hedging tool for the stock market, have become even more popular among investors in this particular period of multinational trade friction. However, everything has its pros and cons, and to gain extra income you must first bear the corresponding risk, so the purpose of this paper is to introduce stock index futures hedging and its risk management, to analyze and explain the operation and risk of hedging, and to empirically test the analysis and application of the hedging strategy, thus providing a theoretical reference for investors' practical operation.

An Empirical Case Study of Foreign Asset & Derivatives Leverage Effect on the Shipbuilding Firms

Purpose – This study aims to analyze the foreign asset leverage effect on Korean shipbuilding companies’ foreign profitability and maintain the appropriate foreign asset size for reducing exchange risk. Design/Methodology/Approach – As a research method, a simple average difference comparison method was used to estimate and compare the difference from the total average value for each variable. Our paper proceeds in presenting serial-stage analysis considering exchange risk factors through estimation on transformation of foreign transactions & derivatives including annual trends of foreign asset and industrial characteristics. Findings – The value of the foreign asset leverage effect on shipbuilding companies was -36.4, and the result was more negative than other industries. This is because ship manufacturing companies focus more than 85% of their sales on overseas transactions and have large amounts of transaction units. Especially, the proportion of the gains from the derivatives book valuation process accounts for 109.8% of the net foreign profits. Research Implications – We need to introduce an independent credit rating system for foreign currency accounts which reflect the relating stability of the foreign currency denominated transaction on global business companies. From a long-term perspective, the exchange risk management of global companies requires relationships and mutual understanding with stakeholders in addition to financial hedging tools.

Market efficiency and information flow between the crude palm oil and crude oil futures markets

This study analyzes the efficiency of the crude palm oil (CPO) futures market by conducting a variance ratio test and comparing it to the West Texas Intermediate (WTI) futures market. We discover that the weak-form efficient market hypothesis holds for both the CPO and WTI futures markets despite the significant difference in their liquidity. Using a scaling exponent, we investigate speculative trading activities and find that trading CPO futures in expectation of significant returns does not strongly involve a high level of risk unlike WTI futures. Our findings regarding market efficiency of the two futures markets are supported by the significant integration of the two with similar level of information flow from each market to the other. To explore the role of speculation in their market integration, we introduce a natural experimental setting using the coronavirus disease 2019 (COVID-19) pandemic, which caused a sudden decrease in the demand for fuel. The bidirectional information flow between the two markets is intensified after the COVID-19 pandemic due to lower level of speculation. The findings suggest that (i) stakeholders in the CPO market need to pay attention to the crude oil markets to anticipate its price changes, (ii) investors can use WTI futures as a hedging tool against CPO futures as long as there is mutual information flow, and (iii) regulators should carefully implement new CPO futures market policy, as either asymmetric changes in speculation or unbalanced regulation with the WTI futures market can create market distortion and regulatory arbitrage.

The Impact of Crude Oil Price Shocks on Bitcoin under the Russian–Ukrainian War

Nowadays, the Russian-Ukrainian war has been a hotly topic, and the war has shaken the global economy, especially in the international crude oil market. Also, as a popular financial instrument, the investors like to see Bitcoin as a hedging tool, but the problem of whether cryptocurrencies can hedge the volatility of commodity markets lacks a unified explanation. Therefore, the paper wants to find the relationship between Bitcoin and crude oil during the Russian-Ukrainian war. This paper uses data from Bitcoin, crude oil WTI futures, and crude oil Brent futures, and constructs the VAR model and ARMA-GARCH model based on these data. Ultimately, the article finds that the volatility of the international crude oil market only has little impact on Bitcoin. Thus, the investors do not need to worry about the high crude oil price caused by the war will affect Bitcoin’s yield and volatility, so Bitcoin seems like a great hedging instrument against the shock of the international crude oil market.

Multiscale dependence, spillovers, and connectedness between precious metals and currency markets: A hedge and safe-haven analysis

In this study, we examine the frequency volatility spillovers, connectedness, and quantile dependence between precious metals futures (gold, palladium, platinum, and silver) and the main US foreign exchange rates of Australia, Canada, China, Eurozone, Japan, Switzerland, and the UK. We use them as a hedging tool for developed currency markets. We further investigate the key drivers of frequency spillovers, before and during COVID-19, and the property of precious metals as a hedge and safe haven against currency risk exposure. We performed the quantile coherency analysis and found that the dependence is positive among the currencies and negative between currencies and precious material in most cases. Using the time-frequency spillovers analysis, we show that gold and silver are net transmitters of spillover to the other markets; however, palladium is a net receiver of spillover for all three horizons. The EUR is a net contributor of risk regardless of the time horizon. Using the quantile regression model, we demonstrate that the effect of the West Texas Intermediate crude oil price (WTI), Economic Policy Uncertainty (EPU) index, volatility index (VIX), and USD index (USDX) on total spillover varies over quantiles in terms of magnitude and direction. Finally, we show that all precious metals can be used as a strong hedge against these major currencies.

Time and frequency dynamics of connectedness between cryptocurrencies and commodity markets

This paper analyses the time and frequency dynamics of connectedness between cryptocurrencies and commodity sectors. It supports that cryptocurrency plays a virtual character in the global financial markets. The total spillovers from cryptocurrencies to commodity markets alternate during the COVID-19 period. The time-frequency domain spillover results illustrate that both in the short-run and long-run, cryptocurrencies contribute to the system as the main transmitter in risk spillover. Besides, the net spillover alternatives with time in different frequencies. The portfolio results illustrate that the hedging effect of cryptocurrencies varies among commodity sectors before and after COVID-19. After COVID-19 the cryptocurrencies show a better hedging tool in our system, especially the hedging effect of cryptocurrencies on ENTR and PMTR sectors. Furthermore, investors need to take cryptocurrencies into the portfolio and adjust the weight of cryptocurrencies according to the alternative hedging effectiveness index, especially after COVID-19.

The Concept and Implementation of Contract for Difference in Derivatives Market

Contract for Difference (CFD) is a leverage product that offers exposure to the market by only placing a small margin (deposit) of the total value of the transaction. CFDs provide traders with an advantage when the price of an underlying asset goes up (by taking a long position) or when it goes down (by taking a short position). When a CFD contract is closed, traders will receive or pay a certain amount of value that arises due to the difference between the purchase price and the selling price of an underlying asset. This shows that CFDs are almost similar to a futures contract in terms of their value derived from various underlying assets and both provide an advantage by providing leverage benefits. Hence, this study aims to examine the concept and course of CFD transactions implemented in Malaysia. This qualitative study applied the content analysis method. Findings show that most traders use CFDs to achieve leverage positions offered by brokers as well as to make short sales and as a hedging tool (hedging mechanism).

Financial Globalization and Its Implications for Asset Allocation in a Dollar World

Unprecedented monetary policy measures carried out by the US Federal Reserve in response to the COVID-19 pandemic have raised the question of whether US dollar hegemony will continue going forward. In this article, the authors examine the multi-faceted nature of dollar hegemony with a focus on its relationship with globalization. They find that the US dollar is the dominant currency in global economic activities ranging from trade to cross-border banking, and this USD strength is reflected in the ability of US Treasuries to diversify local economic shocks. While they find that US Treasuries provide <i>historically</i> better diversification for local equity risk than local sovereign debt, in an ultra-low interest rate world, investors will likely need to consider alternative hedging approaches. As an illustration of a potential alternative, the authors turn to the currency markets and show that a short euro versus long Japanese yen position has had stable to improving performance as a hedging tool. The key message is that alternative hedging strategies merit a robust discussion and consideration in a low-yield environment.

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.

Volatility spillovers between fine wine and major global markets during COVID-19: A portfolio hedging strategy for investors

Motivated by the growing necessity of portfolio diversification, this paper investigates the dynamic connectedness among fine wine, equities, bonds, crude oil, commodities, gold, copper, shipping and real estate by applying the Diebold and Yilmaz (2012) approach, based on the time-varying parameter vector autoregressive (TVP-VAR) model of Antonakakis et al. (2020), for the period 1/1/2010-5/31/2021. Our results indicate moderate volatility spillovers among the markets over time, whereas total connectedness is prone to exogenous shocks, reaching its peak during stress periods. Equities, crude oil, gold and fine wine are the net contributors of spillovers, whereas real estate, commodities, copper, bonds and shipping constitute the net receivers of the diffused shocks. Furthermore, we estimate and compare the hedging ability of fine wine, before and after the emergence of the coronavirus pandemic, to instruct investors in rebalancing their portfolio strategies during COVID-19. The empirical findings suggest that fine wine can form an effective hedging tool to reduce the risk deriving from adverse movements of the markets and its hedging ability was enhanced during COVID-19, with few exceptions. Regardless time period, the highest hedging effectiveness can be achieved by taking a long position in the volatility of crude oil and a short position in the volatility of fine wine.

Are timber and water investments safe-havens? A volatility spillover approach and portfolio hedging strategies for investors

Using a time-varying spillover approach, we investigate volatility spillovers between natural alternative investments, i.e. timber and water, and a battery of traditional instruments comprising equities, bonds, crude oil, gold, real estate, shipping and currency, for the period 1/1/2010–9/30/2021. Results show that the sample markets are moderately integrated and total connectedness escalated during stress periods. Moreover, we examine the hedging ability of timber and water by constructing optimal hedge ratios and portfolio weights. Both assets constitute an effective hedging tool for shipping, crude oil and bond investors, with the short position in the volatility of water to provide higher hedging effectiveness.

العلاقة بين التحفظ والتحوط المحاسبي دراسة تطبيقية في عينة من المصارف العراقية

The research aims to test the relationship between accounting conservatism and hedging in the Iraqi banking sector. The research dealt with a sample of (12) banks listed in the Iraqi Stock Exchange from 2009-2019, with (132) views, and the(unconditional) accounting conservatism was identified. As an independent variable andaccounting hedging as a dependent variable, the (unconditional) accountingconservatism was measured through the market value model to the book, while the accounting hedging was measured as a dummy dust, and the results indicated a statistically significant correlation between accounting conservatism and accounting hedging. orientation of the study sample towards proactive accounting conservatism according to its unconditional scale leads to a reduction in the adoption of accounting hedging tools in managing the risks of financial instruments. The reason for this may be due to the presence of a high level of accounting conservatism that makes the bank safe sort of a lot of dangers. Which contributes to reducing reliance on accounting hedging tools.However, this relationship turns out to be negative, that is, the increasing

Does it pay to be a faithful investor? A risk-based approach performance analysis of Islamic funds vs UCITS schemes

PurposeThis paper empirically investigates the performance of Islamic funds, which have been praised for weathering the 2008 financial storm relatively well and compares it to a European product designed to protect the most vulnerable of investors, UCITS funds.Design/methodology/approachThis paper builds on 128 time-series regressions using various factor models to analyse the risk-return relationship of 242 Islamic and UCITS funds relative to a market benchmark, over a 10-year period starting January 2006, to capture severe bear and bull market conditions.FindingsIslamic funds do not face a competitive disadvantage arising from their strict compliance with Sharīʿah principles, and their performance and investment style is relatively similar to UCITS schemes.Practical implicationsIslamic funds represent a low risk investment due to their very mild betas. Therefore, when forming part of a diversified portfolio, they can act as a hedging tool against adverse market movements.Social implicationsMuslim investors are not punished relative to conventional retail investors when following their own beliefs. Other investors can consider Islamic funds in their portfolio allocation, especially those who seek socially and ethically responsible investments.Originality/valueThis paper fills a lacuna in the existing literature, because the sample is made up of Islamic funds established worldwide and includes not only equity, but also fixed income and mixed allocation funds.

Using Options and Futures as Tools of Capital Increase in Digital Economy

The article provides basic notions of derivative market, shows what these finance tools are, how they work and how capital can be increased with their help. By citing examples from historical development and simple conventional examples the mechanism of derivatives’ functioning was explained and their links with underlying assets were studied, for instance it was shown how the value of exchange tool can enter the negative zone. Exchange and OTC markets were analyzed, their value was investigated on the basis of historical statistics of international finance institutions and mechanisms of their interaction with regulators on the territory of the Russian Federation and abroad were researched. Strategies of using these finance tools for speculation, hedging and arbitration were demonstrated, their advantages and disadvantages were identified. As a result the authors put forward strategy of entering overestimated market with the help of options.