Strategic Hedging Research Articles

Partial hedging in credit markets with structured derivatives: a quantitative approach using put options

This study develops a novel method for mitigating credit risk through the use of structured derivatives, focusing in particular on the use of European put options as a strategic hedging tool. Inspired by the work of Merton (1974), our approach introduces the concept of default triggered by the stock price ST breaching a predefined barrier B. By establishing a distributional equivalence between an existing default model and P(ST<B) for a given time T, we demonstrate the potential for reducing the necessary capital allocation for a projected loss X(T) by partially hedging with a European put option. We formulate and solve an optimization problem w.r.t. a specific risk measure to determine the optimal strike price for the option, and our numerical analysis confirms a reduction in the Solvency Capital Requirement (SCR) in markets with and without jumps. Our findings provide (insurance) companies with a pragmatic approach to mitigating losses while maintaining their current risk management framework.

Assessing insurer guarantee cover and risk retention toward SDG 3: a structure-break down-and-out call valuation

The paper develops a down-and-out call option to evaluate the equity of a life insurer. The COVID-19 pandemic challenges captured by the premature feature of the down-and-out call option are also identified as structural breaks incorporated into the contingent claim option. Hedging, shown by the guarantee cover ratio, reflects the insurer’s ability to meet policy commitments. Reinsurance, indicated by the risk retention ratio, distributes insurance risk between the insurer and reinsurer. The insurer engages in those practices aligned with Sustainable Development Goal 3 (SDG 3: good health and well-being). The main findings are as follows. The COVID-19 pandemic harms policyholder protection and deviates from SDG 3 due to financial instability. However, strategic hedging, reinsurance, and government capital injections enhance policy assurances, achieving SDG 3 by increasing payments to policyholders and improving financial stability. Moreover, the risk retention ratio increases during severe COVID-19 periods but decreases with more government capital injections, which can substitute for risk retention. Policy implications suggest that policymakers can mitigate crisis impacts on insurer capacity to fulfill commitments, thereby enhancing life insurance stability and well-being aligned with SDG 3.

Navigating US–China Rivalry in a Multi-aligned Middle East: Understanding India’s Shifting Strategy Towards the Region

Indian economic and strategic involvement in the Middle East has seen a transformation over the past two decades. This development has happened as many observers remark a gradual decline of US influence juxtaposed with China’s growing presence in the region. This article aims to assess how India has managed its bilateral relations with China within this region of increasing economic and strategic interest. Despite a growing literature on the China-India rivalry in Southeast Asia, South Asia or Central Asia, there is a notable dearth of scholarship on the China–India rivalry and its implications in the Middle East. Filling this gap, this article focuses on explaining how India has adapted its policies towards China’s rising influence in Middle Eastern politics. The core argument is that India’s strategy has been shaped by both a perception of declining US’ engagement in the Middle East and by opportunities created by new strategic hedging strategies from key regional players such as Israel, Saudi Arabia, the UAE and Iran. The article determines that India moved over the last decade from a strategy of buck-passing on US’ security provision to one of partial soft balancing of China’s strategic presence in the Middle East. However, the article also notes the limitations of standard theories of balance-of-power and strategic hedging to account for India’s multifaceted approach towards a regional order in flux.

Caught in the Clash of Titans: A Comparative Study of Indonesian and Vietnamese Strategic Hedging

This paper looks into the case of Southeast Asian states’ policy of hedging toward the U.S.-China competition. It examines Indonesian and Vietnamese similar approach to their respective relations with China and the United States in a shifting regional landscape, despite the fact that the two Southeast states have different ideologies and political systems. The authors argue that the fear of abandonment and entrapment drives the Southeast Asian states’ policy preferences to ensure that the United States and China accommodate their interests. Historical baggage, especially the negative historical experiences of both countries with the United States and China, also inhibits the formation of military alliances with the superpowers. This paper compares the two influential Southeast Asian countries in detail and avoids “regional generalizations” about the countries in the region.

Investigating Financial Risk Behavior Prediction Using Deep Learning and Big Data

This paper introduces a sophisticated deep learning model designed to predict high-risk behaviors in financial traders by analyzing vast amounts of transaction data. The model begins with an unsupervised pre-training phase, learning distributed representations that capture complex data relationships autonomously. It then utilizes a deep neural network, enhanced through supervised learning, to classify and predict traders' risk levels effectively. We specifically focus on financial spread trading related to Contracts For Difference (CFD), identifying potential misuse of insider information and assessing the risks it poses to market makers. By distinguishing between high-risk (A-book) and lower-risk (B-book) clients, the model supports strategic hedging decisions, crucial for market stability. Our extensive evaluations confirm the model's robustness and accuracy, highlighting its significant potential for practical implementation in dynamic and speculative financial markets where past trading performance may not predict future outcomes. This advancement not only refines risk management strategies but also contributes broadly to the domain of financial technology.

Hedging strategy of Turkey in great power competition

ABSTRACT Since Russia’s invasion of Ukraine in February 2022, the U.S. and its allies have failed to recruit more states from the developing world to join the Western coalition against Russia and China to defend the liberal international order. As a swing state, Turkey is an example of this trend despite being a NATO ally. Turkey has adopted strategic hedging to avoid taking sides in the U.S.-Russia rivalry and it has been engaging both sides to increase the range of strategic options available to it. The ‘return-maximizing’ and ‘risk-contingency’ measures of hedging have allowed Turkey to cope with competing great powers and the systemic uncertainties simultaneously. The article argues that the Turkey’s hedging against an uncertain future has helped it to extract concessions, elevate its status, preserve the country’s strategic autonomy, and provide regime survival for President Erdoğan despite severe economic problems. However, hedging behaviours have weakened alignment strength between Turkey and its Western allies.

Strategic Hedging in ASEAN: A Response to the Rise of (Beijing and) Washington

This article problematizes three predominant narratives surrounding the behavior of ASEAN member states and the rivalry between Beijing and Washington in the context of ASEAN’s political security. This qualitative research is developed through a mixed assessment of documents, archive, and literature reviews combined with behavioral and contextual observations. Firstly, it questions the narrative of the ‘assertiveness’ of China as a rising power. With close trading relations dating back to the first dynasties, this Paper argues that the notion of China’s assertiveness and aggression is misplaced. As a key regional trade partner, China was never a threat to ASEAN countries. This narrative developed with the growing interest of the United States to contain the region from China over the years. As such, there lies a gap in the literature, which leads to the singling out of narratives that better explain the holistic relation between ASEAN states and China. Secondly, this article surfaces the lack of consistent commitment of the US to the Asia Pacific (also referred to as the ‘Asia Pivot’), other than to signify its interest in aggressively preventing China from dominating the Indo-Pacific. In this sense, the US’ behavior is viewed less as a great power but more as a greatly reactive one. Lastly, hedging is analyzed here as a necessary response to the dynamics of the Indo-Pacific arena and not a manner of indecisiveness among member states, often claimed as ‘small states’ in the face of the rivalry taking place in its backyard. Keywords: ASEAN, assertiveness, China, hedging, strategy

Half-Hearted or Pragmatic? Explaining EU Strategic Autonomy and the European Defence Fund through Institutional Dynamics

In 2016, the EU Global Strategy introduced the ambition of strategic autonomy, referring to the ability to protect the Union against external threats autonomously. To realise this ambition, the EU also launched various capability development initiatives, in particular, the European Defence Fund (EDF). Much of the available literature presents rationalist explanations of the EU’s development of strategic autonomy and the EDF. These studies attribute strategic autonomy ambition to external conditions and consider it as an act of strategic hedging or bandwagoning. However, the subsequent limited progress in actual capability development casts doubt on these explanations. By drawing on historical institutionalism, this study examines the EU’s current approach to strategic autonomy to see whether internal factors would offer an alternative explanation to the disjunction between the ambitions and actions. For this aim, the study scrutinises the evolution of the EDF as an instrument and the role of the Commission as an agent of change. Based on primary and secondary data, the analysis shows that even though external crises have created critical junctures that compel the EU to reorient its goals, the endogenous elements of institutional change have significantly influenced the EU’s choice of means and redistribution of resources. The findings reveal that the Commission’s ability to reinterpret the original rules and exploit gaps and ambiguities in their local enactment in a path-dependent manner has considerably affected the outcome of this change.

IMPACT OF EXCHANGE RATE VOLATILITY ON TAX INCIDENCE FOR INDIAN IT COMPANIES: A COMPARATIVE ANALYSIS

This study investigates the impact of variations in the USD/INR exchange rate on the tax burden of Indian IT enterprises from 2019 to 2023. Exchange rate fluctuations can affect tax obligations by influencing the conversion of overseas income and the efficacy of hedging tactics. The research conducted an analysis using correlation and regression techniques on data from prominent IT companies like as Infosys, TCS, Wipro, Tech Mahindra, and HCL Technologies. The findings indicate a notable and positive relationship between fluctuations in currency rates and tax expenses. Infosys and TCS demonstrate the highest levels of correlation, with around 82.6% and 88.8% of their variation in tax expenses being accounted for by variations in exchange rates, respectively. These findings emphasize the importance of using efficient risk management methods, such as strategic hedging and the strategic placement of subsidiaries, to reduce the negative impact of currency fluctuations on tax-related financial factors. Further research could investigate the role of government policies in mitigating these risks.

Strategic Hedging or Alignment? Qatar’s Foreign Policy Toward Iran in the Wake of the Blockade Crisis

The blockade imposed on Qatar changed the power dynamics in the Persian Gulf, increasing tension and insecurity in the area. Qatar’s ability to overcome the blockade was largely due to its cooperation with Iran, and the two countries’ ties grew as a result. This study investigates whether Qatar’s long-standing hedging toward Iran has changed into an alignment in the wake of the 2017 blockade. The key conclusion of the article is that, despite Qatar’s faint signals of alignment with Iran during the blockade, it did not entirely stray from its hedging strategy. Qatar-Iran relations has been selected as a case study to illustrate the effects of regional developments and security crises on the hedging strategy within the context of the Blockade Crisis.

From Free-rider to Game Changer: China’s Evolving Cooperation, Technology, and Influence in the Middle East

Abstract: This article explores the evolving dynamics of power and technology in the Middle East, with a particular focus on China’s increasing influence in the region. Amidst the shifting balance of global power, China has transitioned from a peripheral player to a significant stakeholder in the Middle East, deploying its technological prowess and, more recently, diplomatic weight. As the United States and the West grapple with the implications of this shift, regional middle powers are not merely spectators in this superpower rivalry; they are resorting to ‘strategic hedging,’ forming their own partnerships focused on economic and knowledge transfer, replacing traditional political and security alignments to address regional and global challenges. The article discusses future regional trends, emphasizing the potential for Asia-Middle East minilateral cooperative frameworks. It concludes by suggesting that the United States should adopt a healthy balance between values and interests and move away from a zero-sum mentality by embracing a more cooperative approach to China’s regional presence. Specifically, the United States should accept global connectivity and sustainability momentum by encouraging more strategic partnerships between Asian and Middle Eastern countries.

In the Era of Uncertainties - Middle Power Politics in a Multipolar World

The Asia-Pacific region has transformed from a colonial past to an emerging economic power hub, thus bringing fluidity to its definition. The Asia Pacific region is a powerhouse of economic, technological, demographic, and social growth, drawing the attention of several scholars to the distinctive hotbed of great power competition and the emergence of a multipolar world order. The article studies the rise of middle powers by understanding the nature of their foreign policy behaviour by re-examining the regional security complexes of the Asia-Pacific region. In trying to bridge the imbalance of power and regionality, the author argues that the geopolitical flux in the security environment has severe implications for regional integration and cooperation. Countries in the Asia-Pacific region intend to constructively engage in widening their multi track diplomacy through multi-layered alignments with numerous formal and informal agencies and thus create multiple centres of power, influence, and order. The Association of Southeast Asian Nations (ASEAN) and ASEAN-plus continue to present themselves as indispensable in order to promote converged strategic hedging, scilicet, pursuing bilateral, minilateral, and multilateral efforts on the chessboard of geostrategic competition of- Low Politics, including supply chains, trade production, cooperation on public health, and infrastructure development; and High Politics, implying defence partnerships and military modernisation agreements. Nonetheless, strategic hedging is not a preferred option for competing powers as it provides these middle power agencies (in bilateral, minilateral, and multilateral) with space, a platform, and channels for pragmatic, cooperative, yet cautious partnerships. However, the region has a myriad of options for tackling the complex nature of ASEAN consensus and self-help governance, thus overlooking its functions of regional security diplomacy and aptitudes of prioritising and advancing the member states internationally.

Firm performance & effective mitigation of adverse business scenarios

An important question for firm management and markets is whether superior capabilities to mitigate the impact of adverse business scenarios lead to higher firm valuation and performance. We address this question by identifying empirical hypotheses from a new channel of the shareholder value maximization theory of risk management and evaluate them by using a new broadly applicable methodology based on the insight that effective risk management practices (e.g., financial, operational, strategic hedging) and other “unclassified” activities should result in a “hedging profile” with a lesser frequency of “bad” business outcomes relative to “good” outcomes. We measure the hedging profile of 5105 firms across 53 industries from quarterly earnings-based return on assets reported in Compustat, and relate it to firm performance using panel regressions while controlling for critical firm characteristics including median earnings and fixed effects for firm, industry, and year. The estimation reveals a strong positive effect of the hedging profile on Tobin's Q, excess returns, and return on assets (with R-squares above 74%). The study's empirical and theoretical results show that firms that exhibit greater capability to mitigate downside business risk experience higher valuations consistent with a new mechanism for shareholder value maximization theory of hedging based on skewness in firm earnings-based returns.

The Strategic Hedging of Nepal under the Competition of China and India

Generally speaking, hedging strategy is used to describe the choice of Southeast Asian countries in the strategic competition between China and the United States. With the intensification of competition between China and India, this concept has also been extended to the strategic choice of South Asian secondary countries. This paper defines hedging as a complex strategic situation and chooses Nepal, which is very special in its geographical location and has a deep dependence on China and India, as the research object of hedging in the secondary countries in South Asia to explore the reasons for its choice of hedging, as well as the benefits of the Nepal Belt under the hedging strategy and the domestic factor h dilemma of Nepal.

Foreign Policy of Bangladesh towards India-China Tussle: A Neoclassical Realist Analysis

The security of South Asia often remains in turmoil because of the rivalry between the neighboring countries. South Asian countries, particularly developing states, adhere to the principles of strategic hedging for security and economic development. Bangladesh, as an ambitious and developing state, is no exception. Aiming for economic prosperity, Bangladesh tries to maintain a balanced relationship with its bordering states. The evolving regional economic and political dynamics are becoming more competitive and challenging than ever before. This competitive environment can enable Bangladesh to pursue economic and political advantages, reflecting neoclassical realism. Considering the South Asian political developments, the India-China relationship serves as the foundation of regional balance. This research utilizes a qualitative methodology based on neo-classical realism to assess previous data and forecast potential intervening variables that drive Bangladesh to achieve strategic balance in its bilateral relationship with India and China. In this context, the study uses the neoclassical realist model to explain the structural and national interests of Bangladesh and the influence of the strategic environment of the region on its foreign policies.

Russia’s Planned Naval Logistics Base on the Red Sea: Regional Security Implications

In 2020, it was announced that Russia signed an agreement with Sudan on the establishment of a naval centre on the Red Sea. While the agreement still has not been ratified by Sudan’s legislative body, which has not been formed, in February 2023 Sudan’s military authorities declared their support for the construction of the Russian naval facility after having reviewed terms of the treaty, which has made the implementation of the project most probable to date. Over the past decade, Moscow has repeatedly demonstrated its desire to obtain naval facilities in the region; this has arguably become a central theme of Russian negotiations with littoral countries. The paper will argue that Russia’s naval presence in the Red Sea and adjacent areas serves the interest of littoral and neighbouring countries in light of Moscow’s historic and contemporary interests, approaches and objectives in the region. The fact that regional powers have already engaged in what has been conceptualized as ‘strategic hedging’ – a geopolitical strategy by which states pursue policies that are in their national interests while not openly antagonizing ‘the hegemon’ – is likely to offer Russia a corresponding window of opportunity.

Turkish Somersault

The concept of strategic hedging and strategic autonomy in the Turkish interpretation makes it possible to understand the multidirectional and sometimes contradictory nature of Ankara’s relations with Moscow in the late 2010s and the early 2020s.

The State of Strategic Hedging: Turkey’s Foreign Policy and Relations with Russia

The article analyzes the multidimensional nature of Turkey’s foreign policy and its relations with Russia in the 2010s and the early 2020s through the prism of strategic hedging concept. Since the late 2010s, Turkey has systematically positioned itself as a power aspiring for significant strategic autonomy in international affairs. Due to a complex of international and domestic reasons, Turkey has been trying to combine different types of balancing and hedging. This strategy enables Turkey to enhance its strategic autonomy in international relations. Russia has become an important source of Turkey’s strategic autonomy while the crisis in Ukraine, with all its negative impact on Turkey, has opened up new opportunities.

Understanding Bangladesh’s Maritime Diplomacy: Strategic Hedging or Peaceful Engagement?

Maritime diplomacy has become an instrument for influencing the power concentration of the Bay of Bengal and the greater Indian Ocean Region (IOR). Given the brewing geopolitical significance of the Bay and the IOR, minor littoral powers like Bangladesh have been adjusting their diplomacy practices to tap the full potential of the renewed interests of the regional and extra-regional powers in this area. The contemporary literature identifies Bangladesh’s management of maritime diplomacy as strategic hedging. The paper challenges the idea and demonstrates that the maritime diplomacy practices of Bangladesh fail to meet the criteria essential to equate those with a strategic hedging approach. Rather the paper terms the maritime diplomacy practices of Bangladesh as peaceful engagement borrowing the ideas of an alternative school of thoughts.

The Political Economy of Singapore and Its Development Strategies under USA-China Power Rivalry: A Choice of Hedging Policies

Since the United States and China established diplomatic relations, this relationship has been encountered many difficulties; for example, the 1989 Tiananmen Square Incident, the 1999 US-led NATO bombing of the Chinese Embassy in Belgrade, the 2001 US-China aircraft collision in China’s Hainan Island, and China’s 15-year World Trade Organization accession negotiation process and its disputes later with the United States under the WTO, etc. Needless to say, the two great powers also have serious debates and arguments on the Taiwan issue. Under this long-term US-China strategic competition and conflict, Southeast Asian countries therefore have their views and considerations. They smartly have cooperated with China on trade and economic issues while are eagerly or kind of faithfully inclined toward the United States on political and militarily issues. This paper therefore wants to review first the neorealist assumptions on great powers’ relations, and then examine US-China strategic competition and rivalry in the Pacific. Also, it introduces Singapore’s domestic politics and foreign policy as well as its strategic hedging considerations and choices under US-China power rivalry and make a conclusion.