Hedge

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Hedge

A transaction that reduces the risk of an investment.

Hedge

To reduce the risk of an investment by making an offsetting investment. There are a large number of hedging strategies that one can use. To give an example, one may take a long position on a security and then sell short the same or a similar security. This means that one will profit (or at least avoid a loss) no matter which direction the security's price takes. Hedging may reduce risk, but it is important to note that it also reduces profit potential.

hedge

A security transaction that reduces the risk on an already existing investment position. An example is the purchase of a put option in order to offset at least partially the potential losses from owned stock. Although hedges reduce potential losses, they also tend to reduce potential profits. See also perfect hedge, risk hedge, short hedge, special arbitrage account.
Case Study A hedge that limits potential losses is also likely to limit potential gains. In May 1997 Georgia entrepreneur and billionaire Ted Turner entered into an arrangement whereby Mr. Turner had the right to sell four million of his Time Warner shares to a brokerage firm at a price of $19.815 per share. At the same time the brokerage firm acquired the right to buy the same four million shares at a price of $30.45. This particular hedge, called a collar, established a minimum and maximum value for four million shares of Time Warner owned by Mr. Turner. In other words, the former owner of the Atlanta Braves, Atlanta Hawks, CNN, and superstation WTBS acquired the right to obtain at least $19.815 per share by agreeing to give up any increase in value above $30.45. Time Warner stock subsequently skyrocketed when America Online acquired the firm at a price nearly triple the $30.45 stipulated in the agreement. Thus, the hedge ended up costing Mr. Turner approximately a quarter of a billion dollars. On a positive note, the four million shares represented less than 4% of Mr. Turner's total holdings of Time Warner stock he had acquired when the firm bought his Turner Broadcasting several years earlier.
References in periodicals archive ?
Theoretical values of the option to be hedged (as well as standard options if used as hedging instruments) are computed based on the calibrated model and then either a delta hedging strategy or option hedging strategy is determined based on this risk adjusted valuation.
We propose to model the implied volatilities directly when computing a hedging strategy using standard options as hedging instruments.
We show that the risk minimization hedging using the underlying as the hedging instrument outperforms the delta hedging strategy in the section "Hedging Using the Underlying Asset.
In this article, we are interested in computing an optimal hedging strategy, under an assumed statistical market price model, for a variable annuity which has a minimum death guarantee benefit with a ratchet feature.
In particular, at any time t and underlying price St, a delta hedging strategy is determined by first computing the option value V([S.
This is a question of option hedging in an incomplete market and the optimal hedging strategy can be computed to minimize a measure of the hedge risk.
In both cases, the technique consists in ensuring a match between offsetting gains and losses on hedging strategy positions in net income for the same periods.
This results in what is referred to as the "selective" hedging strategy.
The forward-rate adjusted returns associated with the selective hedging strategy, |Mathematical Expression Omitted~, are stated as
Empirical support for use of the selective hedging strategy is provided in the studies by Alexander and Thomas |1~, Chiang |6~, and Meese and Rogoff |24~, |25~, |26~.
The results for both the one-month and three-month horizons show that the selective hedging strategy results in the highest (lowest) mean monthly forward-rate adjusted return (standard deviation) for all currencies.
Determining which hedging strategy is optimal depends on the assumptions concerning the form of the exporter's utility function and, as explained earlier, the distributional properties of the forward-rate adjusted return outcomes associated with each hedging strategy.