Price Hedging Research Articles

Vertical integration as an input price hedge: The case of Delta Air Lines and trainer refinery

AbstractIn April 2012, Delta Air Lines (Delta) purchased a mothballed oil refinery. We use this case to illustrate when, how, and why vertical integration (VI) can hedge input price risk. First, we show that stockholders and creditors expected the move to create wealth. Consistent with their predictions, Delta's exposure to refining margins, cash flow volatility, cost of debt, and default probability all decreased, relative to peers, postacquisition. Our evidence is consistent with the refinery influencing Delta's operating strategies, especially in its most affected markets. The case demonstrates how asset specificity and financial hedging frictions can justify VI.

Corporate Hedging, Information Environment, and Stock Price Crash Risk

This study investigates the effect of corporate derivatives usage on stock price crash risk. We test two competing hypotheses. Under the transparency hypothesis, derivatives usage reduces information opacity and lowers crash risk. Under the speculation hypothesis, derivatives usage exacerbates managerial short-termism and increases crash risk. We find evidence supporting the transparency hypothesis. This result is robust to sensitivity checks including a two-stage treatment model, difference-in-differences test, and subsample analysis. We further show that curbing bad news hoarding, curtailing overinvestment, and increasing breadth of ownership are potential channels through which derivatives usage mitigates crash risk. Additional tests on the effect of derivatives usage on likelihood of securities class-action litigation provide consistent results.

The Impact of Regulations on Price Discovery and Hedge Efficiency in Korea Derivatives Markets

The Impact of Regulations on Price Discovery and Hedge Efficiency in Korea Derivatives Markets

Brent prices and oil stock behaviors: evidence from Nigerian listed oil stocks

BackgroundGiven the shale oil glut that culminated in the most recent and continuing oil price drop from June 2014 and the global financial crisis of 2008 that triggered a cyclical downturn in oil prices and stock market activity, this study investigates the impact of Brent oil price shocks on oil related stocks in Nigeria.MethodsThis study uses a vector autoregressive (VAR) model with the impulse response function and the forecast variance decomposition error.FindingsThe empirical evidence reveals that oil price shocks have a negative impact on Nigerian oil and gas company stocks. In theory, this situation should apply to oil importing countries and is therefore uncharacteristic of an oil exporting country like Nigeria.ConclusionsThe findings suggest that oil companies operating in Nigeria should diversify their investments to protect their business from single-sector market forces, and can also embrace the advantages of outsourcing some of their operations to specialist providers to increase flexibility and reduce operating costs. Finally, for vertically integrated oil and gas companies, oil price hedging and energy risk management will be beneficial because it will mean that these companies will take a position in the crude oil futures market. This will allow for better cash flow management and flexibility.Originality/valueThis study extends the existing literature in two distinct ways. First, it provides, to the best of our knowledge, the first examination of the impact of oil price shocks on stock market activities with a focus on the market returns of oil and gas companies listed in the Nigerian Stock Exchange. Second, this study uses daily data because high frequency data contain more information than lower frequency data does, and lower frequency data average out too much important information.

Pricing and hedging options in normal tempered stable process with 4/2 stochastic volatility

In this paper, we introduce 4/2 stochastic volatility into the Normal Tempered Stable process (NTS-4/2SV). Furthermore, a L$\acute{\text{e}}$vy-based 4/2 stochastic volatility model considering the leverage effect (NTS-4/2SVR) is also proposed. We prove that explicit formulas for option pricing and variance-optimal hedging strategy still work. As an application, we price VIX derivatives with quasi-closed form solutions under both models.

Quantile Hedging in a semi-static market with model uncertainty

With model uncertainty characterized by a convex, possibly non-dominated set of probability measures, the agent minimizes the cost of hedging a path dependent contingent claim with given expected success ratio, in a discrete-time, semi-static market of stocks and options. Based on duality results which link quantile hedging to a randomized composite hypothesis test, an arbitrage-free discretization of the market is proposed as an approximation. The discretized market has a dominating measure, which guarantees the existence of the optimal hedging strategy and helps numerical calculation of the quantile hedging price. As the discretization becomes finer, the approximate quantile hedging price converges and the hedging strategy is asymptotically optimal in the original market.

Erratum to: A Comparison Principle for PDEs Arising in Approximate Hedging Problems: Application to Bermudan Options

In a Markovian framework, we consider the problem of finding the minimal initial value of a controlled process allowing to reach a stochastic target with a given level of expected loss. This question arises typically in approximate hedging problems. The solution to this problem has been characterised by Bouchard et al. (SIAM J Control Optim 48(5):3123–3150, 2009) and is known to solve an Hamilton–Jacobi–Bellman PDE with discontinuous operator. In this paper, we prove a comparison theorem for the corresponding PDE by showing first that it can be rewritten using a continuous operator, in some cases. As an application, we then study the quantile hedging price of Bermudan options in the non-linear case, pursuing the study initiated in Bouchard et al. (J Financial Math 7(1):215–235, 2016).

Errata for the article “Pricing and static hedging of American-style options under the jump to default extended CEV model”

Abstract This errata corrects an error in Ruas et al. (2013, Equation 27) and updates the numerical results contained in Ruas et al. (2013, Tables 4 and 5). The material provided here is meant to be read strictly in conjunction with Ruas et al. (2013).

A Comparison Principle for PDEs Arising in Approximate Hedging Problems: Application to Bermudan Options

In a Markovian framework, we consider the problem of finding the minimal initial value of a controlled process allowing to reach a stochastic target with a given level of expected loss. This question arises typically in approximate hedging problems. The solution to this problem has been characterised by Bouchard, Elie and Touzi in [1] and is known to solve an Hamilton-Jacobi-Bellman PDE with discontinuous operator. In this paper, we prove a comparison theorem for the corresponding PDE by showing first that it can be rewritten using a continuous operator, in some cases. As an application, we then study the quantile hedging price of Bermudan options in the non-linear case, pursuing the study initiated in [2]. [1] Bruno Bouchard, Romuald Elie, and Nizar Touzi. Stochastic target problems with controlled loss. SIAM Journal on Control and Optimization, 48(5):3123-3150,2009. [2] Bruno Bouchard, Romuald Elie, Antony R\'eveillac, et al. Bsdes with weak terminal condition. The Annals of Probability, 43(2):572-604,2015.

Forecasting Price Direction, Hedging and Spread Options in Oil Volatility

The energy market aims to manage risks associated with prices and volatility of the asset. It is a capital intensive market, rippled with a range of chaotic, complex and dynamic interaction among its supply and demand derivatives. Models help users forecast such interactions, to provide investors with empirical evidence of the price direction. Evolutionary modeling is an art, whose science seeks to analyze input data and yield an optimal, complete solution for which conventional methods yield a corresponding, non-cost effective solution. Its solutions are tractable, robust and low-cost with a tolerance of ambiguity, uncertainty and noise as applied to its input. Our study aims to predict the OPEC Oil market with data collected over the period.

Derivative Instruments Dedicated for Agricultural Commodity Entities in Poland

The aim of the research, the results of which are presented in this paper, was to determine how agricultural derivatives imply financial results of the company dealing with wheat trading. The article consists of two parts. The first one presents possibility for applying agricultural derivatives in Poland. The second part contains the results of the research demonstrating the impact of agricultural derivatives on price hedging in the course of wheat trading based on chosen company.

Hedging of Time Discrete Auto-Regressive Stochastic Volatility Options

Numerous empirical proofs indicate the adequacy of the time discrete auto-regressive stochastic volatility models introduced by Taylor (Taylor S. J. [1982]; Taylor S. J. [1986]; Taylor S. J. [2005]) in the dynamical description of the log-returns of financial assets. The pricing and hedging of contingent products that use these models for their underlying assets is a complicated task due to the incomplete nature of the corresponding market and the non-observability of the associated volatility process. In this paper we introduce new pricing kernels for this setup and apply two existing volatility filtering techniques available in the literature for these models, namely Kalman filtering and the hierarchical-likelihood approach, in order to implement various pricing and dynamical hedging strategies. An extensive empirical analysis using both historical returns and options data illustrates the advantages of this model when compared with more standard approaches, namely Black-Scholes and GARCH.

Black Scholes Pricing and Dynamic Hedging

Black Scholes Pricing and Dynamic Hedging

Apoyos para maíz en México: el programa gubernamental de agricultura por contrato

Desde hace poco más de una década, el gobierno mexicano ha venido aplicando dos programas de subsidios para proteger a productores y empresas compradoras de granos de los riesgos de las fluctuaciones de los precios de esos bienes a nivel internacional. Este tipo de apoyos, plasmados en los programas denominados “agricultura por contrato” y “coberturas de precios”, son el objeto de la investigación. Se estudian sus características centrales, así como sus limitantes y efectos, tanto en los productores de maíz del estado de Puebla, como en las firmas pecuarias compradoras de dicho grano. Entre los hallazgos de la investigación figura el hecho de que si bien los programas ofrecen importantes ventajas a los participantes, son frecuentes los incumplimientos de contratos debidos a desastres climáticos, relación de precios (internacionales vs. mercado libre) y evolución del tipo de cambio. Se reseña también el carácter regresivo de los apoyos y su concentración geográfica. La necesidad de reorientar la política de subsidios agrícolas en México es una de las conclusiones del artículo, señalando las posibles alternativas.

Pricing and static hedging of American-style knock-in options on defaultable stocks

Abstract This paper applies the static hedge portfolio approach (SHP) of Chung et al. (2013) in two new directions. First, the SHP approach is generalized from the constant elasticity of variance (CEV) model of Cox (1975) to the jump to default extended CEV (JDCEV) framework of Carr and Linetsky (2006). For this purpose, the recovery value of the American-style down-and-in put is hedged through the one attached to a European-style plain-vanilla contract whereas for an up-and-in put it is necessary to use the recovery component of the corresponding European-style up-and-in option. Second, the SHP methodology is adapted from single to double barrier American-style knock-in options by matching the value of the hedging portfolio along both lower and upper barriers. Finally, and to benchmark the accuracy of the novel SHP pricing solutions, the optimal stopping approach of Nunes (2009) is also extended to price American-style double knock-in options under the JDCEV framework. Such extension highlights the relevant credit derivative component embedded in American-style knock-in equity puts.

Instantaneous Mean-Variance Hedging and Sharpe Ratio Pricing in a Regime-Switching Financial Model

□ We study hedging and pricing of claims in a non-Markovian regime-switching financial model. Our financial market consists of a bank account and a risky asset whose dynamics are driven by a Brownian motion and a multivariate counting process with stochastic intensities. The counting process is used to model the switching behavior for the states of the economy. We assume that the trajectory of the risky asset is continuous between the transition times for the states of the economy and that the value of the risky asset jumps at the time of the transition. We find the hedging strategy that minimizes the instantaneous mean-variance risk of the hedger’s surplus, and we set the price so that the instantaneous Sharpe ratio of the hedger’s surplus equals a predefined target. We discuss key properties of our optimal price and optimal hedging strategy.

Pricing and static hedging of European-style double barrier options under the jump to default extended CEV model

This paper develops two novel methodologies for pricing and hedging European-style barrier option contracts under the jump to default extended constant elasticity of variance (JDCEV) model, namely: a stopping time approach based on the first passage time densities of the underlying asset price process through the barrier levels; and a static hedging portfolio approach in which the barrier option is replicated by a portfolio of plain-vanilla and binary options. In doing so, both valuation methodologies are extended to a more general set-up accommodating endogenous bankruptcy, time-dependent barriers and the commonly observed stylized facts of a positive link between default and equity volatility and of a negative link between volatility and stock price. The two proposed numerical methods are shown to be accurate, easy to implement and efficient under both the JDCEV model and the nested constant elasticity of variance model.

Role of Indian Commodity Derivatives Market in Hedging Price Risk: Estimation of Constant and Dynamic Hedge Ratio, and Hedging Effectiveness

This  paper  examines  hedging  effectiveness  of  four  agricultural  (soybean,  corn,  castor seed and guar seed) and seven non-agricultural (gold, silver, aluminium, copper, zinc, crude oil  and,  natural  gas)  futures  contracts  traded  in  India,  using  VECM  and  CCC-MGARCH model to estimate constant hedge ratio and dynamic hedge ratios, respectively. We ind that agricultural  futures  contracts  provide  higher  hedging  effectiveness  (30-70%)  as  compared to  non-agricultural  futures  (20%).  In  the  more  recent  period,  the  hedging  effectiveness  of Indian futures markets has increased. When hedging effectiveness of non-agricultural Indian futures  contracts  with  the  world  spot  markets  (NYMEX  and  LME)  is  analyzed,  hedging effectiveness  increases  dramatically  which  indicates  the  fact  that  Indian  futures  contracts are more effective for hedging exposures to global prices. Other reasons of lower hedging effectiveness  of  Indian  futures  contracts  may  be  low  awareness  of  futures  markets  among participants,  high  transaction  costs  in  the  futures  markets,  policy  restrictions,  inadequate contract design, or high transaction costs in the spot market. These are, of course, expected birth pays for a nascent futures markets in an emerging economy. ");} // --> activate javascript

Long-Term Profitability of Volume-Based Price Momentum in Taiwan

In the Taiwanese stock market, this paper discovers a significant outperformance of volume-based price momentum strategies relative to pure price momentum strategies over the holding period of 3–5 years. Specifically, hedge portfolios that are longing low-volume winners and shorting high-volume losers generate superior returns than pure price hedge portfolios of buying winners and selling losers. Moreover, the opposed strategies of buying high-volume winners and selling low-volume losers systematically underperform the pure price momentum strategies. Both results are consistent with those from US. More importantly, both outperformance and underperformance are robust to adjustment of industry effects, book-to-market ratio, and firm size. Furthermore, firm size seems to subsume a larger portion of superior and inferior performances than the other two control factors because the economic magnitude of outperformance and underperformance deteriorates more intensively when it is conditional on firm size than on the other two factors.

Analysing Farmers’ Use of Price Hedging Instruments: An Experimental Approach

Abstract This paper analyses the influencing factors of farmers’ use of price hedging instruments (PHIs) based upon a discrete choice experiment with German grain farmers. A mixed logit model is used to determine whether farmers’ choices of PHIs against cash sales are influenced by their price expectation, their risk attitude and their available storage capacities. The results show that farmers with a price expectation below the actual price level have a higher preference for using PHIs against cash sales in general and that the individual degree of risk aversion can have a significant impact on farmers’ choices of a specific PHI. A generally lower preference of farmers with available storage capacities for using PHIs as assumed in many theoretical contributions in the literature, however, cannot be confirmed.