Risk Hedging Research Articles

Volumetric Risk Hedging Strategies and Basis Risk Premium for Solar Power

This article studies volumetric risk hedging strategies for solar power with a twofold proposal of temperature-based and solar power generation–based models for solar power derivatives. It discusses the basis risk arising from a solar power volumetric risk hedge with temperature. Using the two models, the author designs and prices call options written on the accumulated non-cooling-degree days and the accumulated low solar power generation days for hedging cool summer risk, respectively, under the good-deal bounds. Using empirical studies of Czech solar power generation and Prague temperature, the author estimates the models’ parameters and numerically obtain basis risk premiums, that is, solar power generation–based call option prices minus temperature-based call option prices. Results show that premiums increase with temperature up to 25°C and decrease with temperature when it is higher than 25°C. This is consistent with the relationship between solar power generation and temperature. Above 25°C, the relationship is close to linear because of the offsetting effects of increased solar radiation and decreased solar panel efficiency. TOPICS: Portfolio management/multi-asset allocation, ESG investing, factor-based models Key Findings • We examine hedging strategies for solar power’s volumetric risk in cool summers with two call options priced under good-deal bounds using temperature-based and solar power generation-based models and discuss the basis risk from the temperature risk hedge. • Empirical studies using Czech solar power generation and Prague temperature show that the basis risk premiums increase with temperature up to 25°C and decrease with temperature over 25°C. • The latter is consistent with the relationship between solar power generation and temperature because above 25°C, the relationship is close to linear from the offsetting effects of increased solar radiation and decreased solar panel efficiency.

Market Risk Hedging Strategy and Financial Performance at Nigeria Stock Exchange Listed Banks

The main objective of the study was to determine the Market Risk Hedging strategy and financial performance of listed banks at Nigeria Stock Exchange (NSE). Contingency theory and Agency theory were used to expound on the effect of market risk hedging strategy and financial performance. Longitudinal cross sectional survey research design was adopted. The study’s target population includes all the 28 listed banks at Nigeria stock exchange. Data was collected from 2009 to 2018 for 20 listed banks in Nigeria. The secondary data sources for the period of between 2009 and 2018 were collected from Nigeria Stock Exchange and annual reports and accounts of the listed banks. The data was collected from audited financial statements of listed banks and other relevant internal report. Data collected was subjected to diagnosis tests of normality, autocorrelation, multicollinearity, linearity, homoscedasticity, stationarity, fixed and random effects. Correlation analysis was carried out to establish the relationship between the dependent and independent variables. Generalized Least Squares (GLS) regression analysis model was used to establish the relationship and significance between the study variables. The formulated hypotheses were tested. STATA statistical software version 10 was used for data analyses. The study found out that there are positive relationship between market risk hedging strategy and price earnings ratio which is the measure of financial performance of the listed banks at NSE. Based on the findings, the study concluded that Market Risk Hedging Strategies have a significant effect on financial performance of listed banks at NSE. The study recommends that there is need for the listed banks to effectively manage their risk as it was found that risk management positively influence financial performance of listed banks. The study further recommends that there is need for the management of listed banks to constantly check their banks’ exposure to credit risk, insolvency risk, and interest rate sensitivity. Keywords: Market Risk Hedging, Financial Performance. DOI: 10.7176/EJBM/12-15-11 Publication date: May 31 st 2020

Heterogeneous risk preferences in community-based electricity markets

Organization in electricity markets is evolving from centralized pool-based to decentralized peer-to-peer structures. Within this decentralized framework, agents are expected to individually procure their energy, while directly negotiating with other market participants. Since distributed power generation is mostly based on non-dispatchable energy resources with zero marginal cost, any proposed decentralized negotiation mechanism needs to account for uncertainties. When operating uncertain assets, decision makers are affected by subjective attitudes towards uncertain payoffs, impacting not only their energy procurement but also the whole market equilibrium. We propose a new definition of fairness in risky environments and show that, in decentralized electricity markets, heterogeneous risk aversion of participants compromises fairness of the resulting market payments. Consequently, we introduce financial contracts as risk hedging mechanisms and evaluate their impact on market equilibrium and payments. We show that by trading financial products, fairness is restored.

Hedging Longevity Risk in Defined Contribution Pension Schemes

Pension schemes all over the world are under increasing pressure to efficiently hedge the longevity risk posed by ageing populations. In this work, we study an optimal investment problem for a defined contribution pension scheme which decides to hedge the longevity risk using a mortality-linked security, typically a longevity bond. The pension scheme invests in the risky assets available in the market, including the longevity bond, by using the contributions from a representative scheme member to ensure a minimum guarantee such that the member is able to purchase a lifetime annuity upon retirement. We transform this constrained optimal investment problem into an unconstrained problem by replicating a self-financing portfolio of future contributions from the member and the minimum guarantee provided by the scheme. We solve the resulting optimisation problem using the dynamic programming principle and through a series of numerical studies reveal that the longevity risk has an important impact on the performance of investment strategies. Our results provide mathematical evidence supporting the use of mortality-linked securities for efficient hedging of the longevity risk.

Is Indian Equity Options Market Suitable for Hedging When the Options Payoff Structure Changes?

Investments are essential as the growth of the stock market denoted through increased investments results in the growth of the economy. But they are always subject to various risks in the market. These risks are to be mitigated for the development of an efficient economic system by the market itself. Apart from the stock segment, the Indian financial market is a home for futures and options segments that facilitate the hedging of risks involved in the investments. For considering any derivative market as a hedging tool, one of the prerequisites is the presence of integration between such derivative market and its underlying market. The present study focuses on testing the relationship between Indian stock market and the options market, represented by NSE Nifty 50 index and index options on it respectively, to know whether the options segment is suitable for hedging the risks implicit with investments in the stock market, with substantial consideration to payoff structure of the market denoted by different moneyness groups viz.

Accelerated share repurchase and other buyback programs: what neural networks can bring

When firms want to buy back their own shares, they have a choice between several alternatives. If they often carry out open market repurchase, they also increasingly rely on banks through complex buyback contracts involving option components, e.g. accelerated share repurchase contracts, VWAP-minus profit-sharing contracts, etc. The entanglement between the execution problem and the option hedging problem makes the management of these contracts a difficult task that should not boil down to simple Greek-based risk hedging, contrary to what happens with classical books of options. In this paper, we propose a machine learning method to optimally manage several types of buyback contract. In particular, we recover strategies similar to those obtained in the literature with partial differential equation and recombinant tree methods and show that our new method, which does not suffer from the curse of dimensionality, enables to address types of contract that could not be addressed with grid or tree methods.

Investment portfolio Forex risk hedging in the international stock market

Subject. Investment management on the international financial market necessitates a special approach to foreign currency hedging. The majority of international investors fully eliminate risk associated with their foreign-exchange holdings, seeking profits only from stock price differentials. In certain circumstances, a correlation between local currency exchange rate and local stock index may provide additional opportunities for profit generation. Objectives. The aim of the study is to test the hypothesis that partial currency risk-taking may reduce the total portfolio risk and increase return on international investment. Methods. I apply the global optimization approach to calculate investment portfolios for 11 countries of the world. Each portfolio includes shares of 20–25 highly capitalized companies. Descriptive statistic methods are used to check the input data, i.e. random variable calculation, pivot tables. Investment strategy efficiency is assessed based on the Sharpe Ratio, Sortino Ratio, Treynor Ratio and Omega Ratio. Results. Currency hedge position at the rate of about 14 percent of the total portfolio value may increase investment yield by two percentage points annually on the ten-year time span. Conclusions and Relevance. Total currency risk hedge is necessary for investment in developed and developing countries that pursue the policy of regular devaluation of their national currency. Market regulators inside a particular country should take into account that a sudden devaluation of national currency may be needed, if return on the stock market is lower than that of risk-free instruments.

A Simulation about the Impact to Raise the Public Housing Rentals on the Supplier’s Financial Risk Hedge

개발연대에 SH공사는 토지·주택의 분양수입으로 공공임대주택사업의 결손을 교차보존하는 재무구조를 견지하였는데, 향후 서울시의 개발가용지가 거의 고갈된 현실에서도 이 구조가 유효할 것인지 의문이 제기된다. 본 연구는 2019~2028년 기간 중 SH공사의 임대주택사업 매출총손익을 ① 임대료를 동결하는 ‘기본안’에 대비하여; ② 공공·국민임대주택만을 인상하는 ‘대안 1’; ③ 두 주택 외 행복주택을 함께 인상하는 ‘대안 2’; 그리고 ④ 위 3개 유형 외에 다가구임대 등을 함께 인상하는 ‘대안 3’을 통하여서 추정하였다. 기본안은 분석기간 중에 약 4,000~8,300억 원의 매출손실을 유발한 반면, 대안1은 2028년 기준으로 연인상률 1%당 약 46억 원의 매출손실 감소효과를 가져온다(대안2는 약 48억 원 그리고 대안3은 약 60억원을 감소시킨다). 그 간 선행연구들은 입주편익 제고를 위한 저렴한 임대료에만 초점을 맞추었지만, 그 저렴임대료로 인한 공공 공급주체의 존속위험에 대해서는 고려가 미흡하였다. 향후 교차보전구조가 잘 작동하지 않을 수 있고, 이는 단순히 SH의 재무곤경으로 끝나지 않고 주거복지의 중단위협으로 대두된다. SH의 재무위험요인인 임대료 동결, 장기전세제도, 과다한 임대주택 공급물량 등은 더는 방치할 수 없고 시급히 해결해야 할 현안이라고 판단된다.SH (Seoul Housing and Communities Corporation), entirely owned by Seoul Metropolitan Government, has steadily sustained the management scheme to offset the losses from public housing with the gains from sales of land and homes. Though, it is fairly questionable that the structure can be effective under the pressure of depletion of developable land in Seoul. The purpose of this study is to simulate the gross profit of SH during 2019 and 2028 under the four different assumptions concerning rental escalation: the first and basic plan is no hike-up while other three alternatives are discriminated by the combination of housing types included in escalation plan. The basic plan is estimated to generate the gross losses between KRW 400 billion in 2019 and KRW 830 billion in 2028 while Alternatives 1, 2 and 3, corresponding to 1% of annual growth rate, are expected to reduce the losses by KRW 4.6 billion, KRW 4.8 billion and KRW 6 billion in 2028 alone, respectively. Earlier studies have obsessed with affordable rentals for the vulnerable hierarchy in housing but neglected the sustainability of service providers in public housing. Since the financial distress of SH can entail the discontinuance of service, it is the time to consider uplifting their profitability in public housing.

Retracted: Risk Management in Financial Institutions

ABSTRACTWe study risk management in financial institutions using data on hedging of interest rate and foreign exchange risk. We find strong evidence that institutions with higher net worth hedge more, controlling for risk exposures, across institutions and within institutions over time. For identification, we exploit net worth shocks resulting from loan losses due to declines in house prices. Institutions that sustain such shocks reduce hedging significantly relative to otherwise‐similar institutions. The reduction in hedging is differentially larger among institutions with high real estate exposure. The evidence is consistent with the theory that financial constraints impede both financing and hedging.

Would Ambiguity Averse Investors Hedge Risk in Equity Markets?

This paper studies the conjecture that investors prefer derivative markets over the equity market when hedging risks. An investor who wants to hedge, say inflation or crash risk, generally faces substantially more beta uncertainty in the stock market than in the derivatives market. We show that an investor with smooth ambiguity aversion preferences avoids a hedge portfolio consisting of stocks, which is typically subject to large beta uncertainty. The ambiguity averse investor prefers to hedge using derivatives (TIPS and options) which are not subject to beta uncertainty. More specifically, we show that equilibrium risk premiums for assets with large beta uncertainty (long-short portfolio of stocks) decline once derivatives with less beta uncertainty (TIPS and options) are introduced. In line with this theory, we find that the inflation risk premium decreases significantly, in absolute terms, when TIPS are introduced.

The financialization of Chinese commodity markets

This study investigates the financialization of China's futures market from a market-integration perspective. First, this study examines the integration between the commodity market and financial capital markets (stock/bond/foreign exchange markets) by using multivariate GARCH models. We find that China's commodity futures market, especially the energy futures market, has financialization phenomenon. Moreover, the energy futures market plays a leading role in the integration between the commodity and stock markets. Considering that commodity market financialization is intimately associated with financial investment, this study analyzes the optimal intermarket risk hedging and asset allocation strategies between commodities and financial assets during its financialization.

Production Planning with Risk Hedging under a CVaR Objective

A central problem in planning production capacity is how to effectively manage demand risk. We develop a model that integrates capacity planning and risk hedging decisions under a popular risk measure, conditional value at risk (CVaR). The CVaR objective generalizes the usual risk-neutral objective (such as the expected payoff), and allows for explicit modeling of the degree of aversion to downside risk (associated with low demand). The starting point of our model is to incorporate the impact on demand from a financial asset (including, for instance, a tradable market index as a proxy for the general economy) via a demand rate function. This way, in addition to the capacity decision at the beginning of the planning horizon, there is also a dynamic hedging strategy throughout the horizon, the latter plays the role of both mitigating demand risk and supplementing the payoff. The hedging strategy is restricted to partial information along with a cap on loss (pathwise). To find the optimal hedging strategy, we construct and solve a dual problem to derive the optimal terminal wealth from hedging; the real-time hedging strategy is then mapped out via the martingale representation theorem. With the hedging strategy optimized, we show that optimizing the production quantity is a concave maximization problem. With both production and hedging (jointly) optimized, we provide a complete characterization of the efficient frontier, and quantify the improvement over the production-only approach. Furthermore, via sensitivity and asymptotic analyses, we spell out the impacts of the hedging budget and the risk aversion level, along with other qualitative insights.

FUTURESCONTRACTS AS A HEDGING TOOL FOR CURRENCY RISK IN UKRAINE

The article discusses the concept, principle and purpose of hedging as an approach to price and currency risk management. The main currency risk hedging instruments are specified. Also the main currency risk hedgers and foreign exchange futures peculiarities have been identified.The state and dynamics of derivatives market development in Ukraine have been studied. The types of derivatives that are most in demand on exchanges have been identified. The volume and share of derivatives in the traders' exchanges were analysed. The basic prerequisites that have formed the necessity of development of the currency derivatives market in Ukraine are indicated.Advantages and disadvantages of using foreign exchange futures to minimize enterprises and agricultural producers currency risks have been defined. The main problems impeding the development of the domestic derivatives market and reasons for the low use of hedging instruments in Ukraine have been identified, in particular: lack of investment, reduction in derivatives transactions, underdevelopment of derivatives needed for hedging, insufficient infrastructure for futures trading, low awareness of economic agents of the possibilities of hedging through derivatives transactions, domination of speculative motives.Based on the derivatives market characteristics in Ukraine, recommendations to expand the monetary market and create conditions for the spread of financial risk hedging have been proposed.

Are Cryptocurrencies a Safe Haven for Equity Markets? An International Perspective from the COVID-19 Pandemic

The COVID-19 pandemic provided the first widespread bear market conditions since the inception of cryptocurrencies. We test the widely mooted safe haven properties of Bitcoin, Ethereum and Tether from the perspective of international equity index investors. Bitcoin and Ethereum are not a safe haven for the majority of international equity markets examined, in fact increasing portfolio downside risk. Only investors in the Chinese CSI 300 index realized modest downside risk benefits, but only from small relative allocations to Bitcoin or Ethereum. As Tether successfully maintained its peg to the US dollar during the COVID-19 turmoil, it acted as a safe haven investment for all of the international indices examined. We caveat the latter findings with a warning that this dollar peg has not always been maintained, impairing the earlier downside risk hedging properties of Tether.

ДЕРИВАТИВИ ЯК ФІНАНСОВІ ІННОВАЦІЇ ФІКТИВНОГО КАПІТАЛУ

The article considers the economic nature of derivatives as financial innovations of fictitious capital. Their essence and various classification forms are characterized. It is determined that derivatives are used mainly for risk hedging, as well as for the implementation of investment strategy. Derivatives as innovative financial products are formed as a result of specific relations of economic entities in the process of their innovative activity in the financial market. These relationships allow to meet the needs associated with the search for sources of funding, involve virtually unlimited opportunities for variation in the amount of risk and its redistribution, provide liquidity and increase the final financial results. By setting future prices, participants in futures contracts can plan their activities in the future. Prices in this market are a kind of indicator of the future state of the economy. The development of the derivatives market in Ukraine is slow, and is accompanied by low trading volumes and a rather limited range of derivative securities used as a hedging instrument, so it is important to study global trends in its operation at the present stage. In the context of financial globalization, derivatives are an integral part of global capital markets, and derivatives help a wide range of end users to manage risk and improve profits. Participants in the global derivatives market say that their liquidity remains unchanged or improves in 2019, with more than 80% expecting the same in 2020. Such positive sentiment from end consumers, investors, clearing companies, brokers, traders and exchanges, participating in global derivatives markets is an indicator of high confidence. The analysis of the functioning of the world derivatives market and the development of the derivatives market in Ukraine is carried out. Positive and negative tendencies of development of this market are revealed. The main problematic aspects that hinder the effective operation of the domestic derivatives market are outlined. Based on the analysis of the state and dynamics of the derivatives market in Ukraine, the main directions of its development are proposed.

An Investment Strategy Based on Life and Business Cycles

This study develops an investment strategy that considers both the life cycle and the business cycle by investing in the market index of emerging and global markets (called the Business and Life Cycle Fund (BLCF)). Considering the change in investors’ risk capacity depending on their age, we propose a model similar to the Target Date Fund (TDF), that incorporates the life cycle. We also incorporate the business cycle into the model for excess returns, which leads the model to invest more in emerging markets during economic booms and to shift the portfolio’s weight to the global market during recessions. To mitigate market risk, we include additional assets that move in an opposite direction to business cycles. The resulting model provides higher annual returns and a higher Sharpe ratio than does the model that encompasses only the life cycle model and other market indices individually. In addition, a model that considers risk hedging shows higher annual returns and a higher Sharpe ratio than does the model encompassing only the business and life cycles. These results contribute to future TDF modeling as well as to Korean policymakers’ default option decision issue. Key words: TDF; BLCF; Business Cycle; Business Reversible Assets; Default Options JEL Classification: G1

Hedging as a Method of Price Risk Management

Derivative financial instruments have great importance in the fight against financial risks. The purpose of applying to derivative financial instruments is to extract profits from price fluctuations of the corresponding exchange asset, as well as to protect (hedge) against undesirable changes in market prices for the corresponding exchange asset. Risk hedging is based on the strategy of minimizing unwanted risks, so the result of the operation can also be a reduction in potential profit, since profit, as it is well known, is inversely related to risk. If earlier hedging was used exclusively for minimizing price risks, then at present the goal of hedging is not to remove risks, but to optimize them. In the article, the authors made conclusions about the existing value of hedging as a tool to reduce the risk associated with the adverse effect of market factors on the price of another instrument associated with it, or on the cash flows generated by it.

Spillover Effects Between Stock Prices and Exchange Rates for the Central and Eastern European Countries

This article attempts to empirically analyze the dynamic relationship and volatility spillover effects between exchange rates and stock returns of the five Central and Eastern European (CEE) countries (Hungary, Poland, the Czech Republic, Romania and Croatia) covering the period 2000–2017 by using the bivariate generalized autoregressive conditional heteroskedasticity-Baba, Engle, Kraft and Kroner (GARCH-BEKK) framework alongside with the constant and dynamic conditional correlation (CCC and DCC) models. The major findings reveal the following: bidirectional volatility spillovers between the two financial markets in Hungary, the Czech Republic and Croatia in the pre-crisis period; unidirectional spillover of volatility from the stock market to foreign exchange market for Poland during the sub-prime crisis period; unidirectional spillover of volatility from the foreign exchange market to the stock market for Hungary in the post-crisis period and Romania in the pre-crisis period; non-persistence volatility spillover between them in case of the Czech Republic, Romania and Croatia in the post-crisis period; the absence of volatility transmission from the stock market to foreign exchange market occurs in Hungary, while from the foreign exchange market to the stock market in case of Poland in the post-crisis period. We further find a short-lived but non-negligible financial contagion between stock and foreign exchange market in these countries. These empirical insights have significant implications for portfolio investments and currency risk hedging.

Managing foreign exchange risk with buyer–supplier contracts

We model the optimal choice of the contract terms of a foreign exchange risk sharing supply contract between a buyer and supplier who are located in two different countries, when the supplier quotes a wholesale price in its currency, and both parties are mean variance expected utility maximizers. We extend the model to examine alternatives to the risk sharing contract, which are the wholesale price contract without risk hedging and a wholesale price contract with transfer of risk by the buyer to an options dealer. We empirically apply the model, to two different currencies of the supplier, by assuming that the buyer is based in the U.S., while the supplier is based in one of two countries, which are Switzerland and the U.K. Our results show that the performance of the risk sharing contract provides a substantial improvement in the total expected utility of both partners to the contract, over both the wholesale price contract without risk hedging and the risk transfer contract.

Power option pricing under the unstable conditions (Evidence of power option pricing under fractional Heston model in the Iran gold market)

Instability and excessive volatilities in the various financial and non-financial markets have increased the importance of risk hedging in investments. So in this paper, the hypothetical options pricing have been done based on fractional Heston model in Iran’s gold market. In fact power option pricing has been driven using fast Fourier transformation (FFT), and maximum likelihood method. The study period has been classified to periods of three months and the profit and loss resulting from this option in each period has been calculated using discount rate based on the consumer price index. Findings indicated in most periods of three months, the model’s determination has been done correctly and the estimated price of power option has prevented the creation of arbitrage opportunity and caused a secure position of investment. But in the two periods related to 2018 due to high volatilities, the power option has created an arbitrage opportunity.