Hedging Effectiveness

Hedging Effectiveness

The extent to which hedging an investment actually reduces risk. There are a large number of hedging strategies one can use. For example, one may take a long position on a security and then sell short the same security. However, some strategies may be forms of naive diversification, which reduce hedging effectiveness. In an extreme example, if one buys a stock and then short sells a bond in a completely different industry, one is more likely to increase risk rather than decrease it.
References in periodicals archive ?
The analysis of perception of brokers about derivative securities is captured in section 6, which is further subdivided into demographics of brokers, trading and marketing activities of brokers, usage and concern about derivative markets, and price discovery and hedging effectiveness in commodity futures.
Allen, "Multivariate GARCH hedge ratios and hedging effectiveness in Australian futures markets," Accounting & Finance, vol.
Our results show that purchasing gap insurance can generally increase the hedging effectiveness in multiple ways by reducing basis risk, thus increasing shareholder value and, at the same time, lowering shortfall risk.
Hedging effectiveness is measured by [R.sup.2] and the basis risk is measured by 1-[R.sup.2].
The hedge ratios are easier to be estimated through rolling window OLS (RW OLS) techniques and provide good results in terms of hedging effectiveness. Lien, Tse and Tsui (2002) found that a constant correlation GARCH model does not provide an improvement of the effectiveness compared to the RW OLS.
Under departures from the cost-of-carry theory, historical market information, conditional variance, and conditional correlation implied from emissions allowances futures markets have significant impacts on time-varying hedge ratios and hedging effectiveness. It is urgent for market participants to know how to increase portfolio revenues and decrease returns risk reduction of emissions allowances assets between spot and futures under departures from the cost-of-carry theory.
These contracts failure can be attributed to various factors which include among others: competition from other contracts or exchanges; low or decreasing hedging effectiveness; future uncertainty (LIFFE investors were faced by monetary uncertainty due to the formation of EU); regulatory changes that may adversely affect a contract; "me too" trend i.e introducing a contract popularly introduced by other exchanges; sophisticated contracts; drop in purchasing power of the investors; failure to keep up with the technology advancement; and, introducing contracts on a "trial and error" basis.
(2005), "Futures Maturity and Hedging Effectiveness: The Case of Oil Futures," Working Paper 513, Macquarie University.
Extreme Volatility, Speculative Efficiency, and the Hedging Effectiveness of the Oil Futures Markets.
This procedure continues until the exotic option matures and the average hedging errors are used as an indicator of the model's hedging effectiveness.
The maritime derivatives BIFFEX ceased to trade mainly because of low hedging effectiveness. The underlying index, which is derived from the price of a basket of routes, could not hedge well for individual route because hedging effectiveness is directly related to the underlying risk.
While selection of the futures' expiration will affect the hedge ratio, and therefore the number of contracts to use, it will not influence hedging effectiveness. In all cases, the perfectly hedged portfolio will earn the risk-less (net) cost of carry return.