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1 – 10 of over 9000Donald Lien and Mei Zhang
A futures contract may rely upon physical delivery or cash settlement to liquidate open positions at the maturity date. Contract settlement specification has direct impacts on the…
Abstract
A futures contract may rely upon physical delivery or cash settlement to liquidate open positions at the maturity date. Contract settlement specification has direct impacts on the behavior of the futures price, leading to different effects of liquidity risk on futures hedging. This chapter compares such effects under alternative settlement specifications with a simple analytical model of daily price change. Numerical simulation results demonstrate that capital constraint reduces hedging effectiveness and tends to produce a lower optimal hedge ratio. As the futures contract proceeds toward the maturity date, hedgers will take larger hedge position in order to achieve better hedging effectiveness. Finally, optimal hedge ratios are higher (resp. lower) under cash settlement for the bivariate normal (resp. lognormal) assumptions, whereas hedging effectiveness is almost always greater under cash settlement.
This paper aims to develop hedging strategies using both futures and forward contracts and issuing risky debt when financially constrained firms are forced to operate in long…
Abstract
Purpose
This paper aims to develop hedging strategies using both futures and forward contracts and issuing risky debt when financially constrained firms are forced to operate in long horizon.
Design/methodology/approach
The authors present a model for developing hedging strategies using both futures and forward contracts and issuing risky debt. A theoretical model employing stochastic differential equations for forward hedging is illustrated with a numerical example over parameter values consistent with the literature.
Findings
A financially constrained firm with limited cash balance must hedge its liquidity with both future and forward contracts and issue risky debt to support its long-term operations. The firm can issue a minimal amount of risky debt by adding forward contracts into hedging and can increase its value higher than that when hedging with only futures contracts. We show numerically that hedging with both futures and forward contracts allows the firm to issue minimal risky debt in increasing its firm value.
Practical implications
When Metallgesellschaft nearly collapsed in 1993, it offered long-term forward contracts to its customers and attempted to hedge its risk by rolling over series of short-term futures contract. It created the situation of inherent mismatch in maturity structure. A financially constrained firm operating in a long horizon appears to commit its liquidity as long-term forward contracts, which cannot be fully hedged with series of futures contacts. The firm should hedge its liquidity with both futures and forward contracts and avoid liquidation with deadweight costs in its long-term operation.
Originality/value
This is the first study examining hedging strategies with both futures and forward contracts.
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Varuna Kharbanda and Archana Singh
Corporate treasurers manage the currency risk of their organization by hedging through futures contracts. The purpose of this paper is to evaluate the effectiveness of hedging by…
Abstract
Purpose
Corporate treasurers manage the currency risk of their organization by hedging through futures contracts. The purpose of this paper is to evaluate the effectiveness of hedging by US currency futures contracts by taking into account the efficiency of the currency market.
Design/methodology/approach
The static models for calculating hedge ratio are as popular as dynamic models. But the main disadvantage with the static models is that they do not consider important properties of time series like autocorrelation and heteroskedasticity of the residuals and also ignore the cointegration of the market variables which indicate short-run market disequilibrium. The present study, therefore, measures the hedging effectiveness in the US currency futures market using two dynamic models – constant conditional correlation multivariate generalized ARCH (CCC-MGARCH) and dynamic conditional correlation multivariate GARCH (DCC-MGARCH).
Findings
The study finds that both the dynamic models used in the study provide similar results. The relative comparison of CCC-MGARCH and DCC-MGARCH models shows that CCC-MGARCH provides better hedging effectiveness result, and thus, should be preferred over the other model.
Practical implications
The findings of the study are important for the company treasurers since the new updated Indian accounting standards (Ind-AS), applicable from the financial year 2016–2017, make it mandatory for the companies to evaluate the effectiveness of hedges. These standards do not specify a quantitative method of evaluation but provide the flexibility to the companies in choosing an appropriate method which justifies their risk management objective. These results are also useful for the policy makers as they can specify and list the appropriate methods for evaluating the hedge effectiveness in the currency market.
Originality/value
Majorly, the studies on Indian financial market limit themselves to either examining the efficiency of that market or to evaluate the effectiveness of the hedges undertaken. Moreover, most of such works focus on the stock market or the commodity market in India. This is one of the first studies which bring together the concepts of efficiency of the market and effectiveness of the hedges in the Indian currency futures market.
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Thiagu Ranganathan and Usha Ananthakumar
The purpose of this paper is to perform an analysis of potential benefits from usage of the futures markets for the farmers. The national commodity exchanges were established in…
Abstract
Purpose
The purpose of this paper is to perform an analysis of potential benefits from usage of the futures markets for the farmers. The national commodity exchanges were established in India in the year 2003-2004. Though there has been a spectacular growth in trading volumes in these exchanges, participation of farmers in these markets has been very low. Efforts are being made to increase the awareness and participation of farmers in these markets. As such efforts are being made, it is critical to analyse the potential benefits from usage of the futures markets for the farmers. Our study performs such an analysis for soybean farmers in the Dewas district of Madhya Pradesh state in India.
Design/methodology/approach
The authors estimate the optimal hedge ratios in futures markets for farmers in different scenarios characterised by varying levels of different parameters relevant to the farmer. For these optimal hedge ratios, we then estimate the benefits from hedging defined as the change in certainty equivalent income (CEI) due to hedging.
Findings
Results indicate that the CEI gain due to hedging is positively related to the farmer’s risk aversion and inversely related to farmer’s price expectations and transaction costs. Also, only when the risk aversion is high, the CEI gain is positively related to the natural hedge. Thus, for a farmer with high risk aversion, hedging acts as a substitute to the natural hedge.
Originality/value
This is the first study that analyses the hedging for farmer in the Indian context by considering yield risk while doing so. Also, their study establishes a relationship between risk aversion, the natural hedge and benefits from hedging in futures markets for the farmer.
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The purpose of this study is to investigate hedging effectiveness of KOSPI200 index futures and options using three measures proposed by Fishburn (1977), Ederington (1979), and…
Abstract
The purpose of this study is to investigate hedging effectiveness of KOSPI200 index futures and options using three measures proposed by Fishburn (1977), Ederington (1979), and Howard and D’Antonio (1987). The comparison of hedging effectiveness is conducted based on the market prices of KOSPI200 index futures and options traded in Korea Exchange (KRX) between January of 2001 and January of 2011, during which bootstrapping method is utilized to make a dataset of 100,000 random samples with holding period of 1, 3, 6, and 12 months, respectively. We examine the hedging performance of hedge portfolios made of short futures, protective puts and covered calls respectively based on three hedging effectiveness measures.
One of our finding is that short futures hedging is better than options in minimizing total volatility risk as well as down-side risk, which is consistent to the previous researches. Also futures hedging is more effective in reducing the VaR than the others. Secondly, the optimal hedge ratios of futures in minimizing total risk and down-side risk are turned out to be 0.97~0.98 and 0.94~0.95 respectively. Third, OTM short call hedge is the best hedging instrument when hedgers would like to maximize the Sharpe ratio. Finally, protective put hedging strategy is in general inferior to the short futures and covered call hedge based on three hedging effectiveness measures.
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Exposure risk managers can hedge exchange rate risk with either currency futures or currency options. It is generally suggested that hedgers should choose a hedge instrument that…
Abstract
Exposure risk managers can hedge exchange rate risk with either currency futures or currency options. It is generally suggested that hedgers should choose a hedge instrument that matches the risk profile of the underlying currency position as closely as possible. This advice, however, ignores the possibility that the hedging effectiveness may differ for the alternate risk management tools. This study compares the effectiveness of currency futures and currency options as hedging instruments for covered and uncovered currency positions. Based on Ederington's portfolio theory of hedging, the results show that currency futures provide the more effective covered hedge, while currency options (used to construct a synthetic futures contract) are more effective for an uncovered hedge. Hence, exposure risk managers do not have to sacrifice hedging effectiveness to obtain the desired risk profile. Corporations engaged in international business transactions are commonly exposed to exchange rate risk. Since management is concerned with currency exposure, it can hedge the anticipated exchange rate risk either with futures or options. The choice of the appropriate hedging tool is generally influenced by the type of currency exposure (transaction, translation, or economic risk), the size of the firm, the industry effect, the risk preference of the manager or the firm and his/her familiarity with the available financial instruments and techniques. It is also suggested that a hedger should choose a hedge instrument that matches the risk profile of the underlying currency position as closely as possible. Hence, futures contracts are more suitable for covered hedges, while option contracts are best used for uncovered hedges. Hedging effectiveness of these two hedge instruments must be considered as well in order to evaluate the cost of obtaining the desired risk profile. Some empirical research has shown that the futures contract provides both an appropriate risk profile and a more effective hedge than an options contract for covered positions. If these findings also hold for uncovered currency positions, then the hedging decision involves a trade‐off between the desired risk profile and hedging effectiveness. That is, a hedger would have to decide whether the extra risk protection afforded by the attractive risk profile of options is worth the loss in hedging performance. This study compares the hedging effectiveness of currency futures and currency options for both covered and uncovered positions. Ederington's risk‐minimizing approach is applied to estimate the hedging effectiveness and the least risk hedge ratios which, in turn, are used to assess the trade‐off between risk profile and hedging performance.
Chyi Lin Lee and Ming‐Long Lee
The hedging effectiveness of real estate investment trust (REIT) futures as a critical issue in response to the global REIT market has been extremely volatile in recent years…
Abstract
Purpose
The hedging effectiveness of real estate investment trust (REIT) futures as a critical issue in response to the global REIT market has been extremely volatile in recent years, however few studies have been placed on this area. This study aims to fill in this gap and examine the hedging effectiveness of Australian and Japanese REIT futures over 2002‐2010.
Design/methodology/approach
The analysis of this study involves two stages. The first stage is to estimate optimal hedge ratios. A variety of hedging methods is employed, including a traditional hedge, an ordinary least squares (OLS) model and a bivariate GARCH model. Thereafter, the hedging effectiveness of these strategies is assessed individually.
Findings
The empirical results show REIT futures are effective hedging instruments in which a risk reduction of 37 per cent‐78 per cent (34 per cent‐52 per cent) for Australian (Japanese) REITs is evident. Importantly, the results also reveal that REIT futures outperform other hedging instruments in which a weaker risk reduction is found by stock, interest rate and foreign currency futures contracts. Moreover, the hedging effectiveness of REIT futures is dynamic and varies over time.
Practical implications
The findings enable more informed and practical investment decision‐making regarding the role of REIT futures in risk management.
Originality/value
This paper, as far as the authors are aware, is the first study to offer empirical evidence of the risk‐reduction effectiveness of REIT futures. The hedging effectiveness of REIT futures is also compared to other hedging instruments for the first time.
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This study aims to spot wheat data and disaggregated commitment of trader data for CME traded wheat futures to examine the effect of exogenous shocks for hedging positions of…
Abstract
Purpose
This study aims to spot wheat data and disaggregated commitment of trader data for CME traded wheat futures to examine the effect of exogenous shocks for hedging positions of Producers and Swap Dealers on cash-futures basis and excess futures returns.
Design/methodology/approach
A Bayesian vector autoregression (BVAR) methodology is used to capture volatility transfer effects.
Findings
Evidence is presented that institutional short hedging positions play a major role in the pricing of asymmetric information held by Swap Dealers into the basis. The results also indicate that producer hedging contains information when conditions in the supply chain create a shift in long vs short hedging demand. Finally, the results demonstrate that that Swap Dealer short hedging has the greatest effect on risk premium size and historical volatility.
Originality/value
Various proxies for spot prices are used in the literature, although actual spot price data is not common. In addition, stationarity for basis and open interest data is induced using the Baxter-King filter which allows us to work with levels, rather than percentage changes, in the time series data. This provides the ability to directly observe the effect of outright open interest positions for hedgers on contemporaneous innovations in basis and in excess returns. The use of a BVAR methodology represents an improvement over other structural VAR models by capturing contemporaneous systemic effects within an endogeneity based structural framework.
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Shi Zheng, Pei Xu and Zhigang Wang
The purpose of this paper is to find factors that explain why some enterprises hedge but others do not. The authors' analysis relies on Heckman model (a probit and Tobit model…
Abstract
Purpose
The purpose of this paper is to find factors that explain why some enterprises hedge but others do not. The authors' analysis relies on Heckman model (a probit and Tobit model) with the data obtained from questionnaires collected from Chinese enterprises. Given the fact that only a small portion of Chinese agribusinesses hedge, this paper provides some initial academic evidence to help the agricultural sector devise useful programs to assist participations of hedging.
Design/methodology/approach
A Heckman selection model was developed to analyze questionnaire information obtained using face‐to‐face interviews with 218 Chinese agribusinesses. This paper presents summary statistics, Heckman estimation results, and interpretations of the results.
Findings
Survey results show that a majority of surveyed firms believe that futures market cannot reduce risks or increase income. According to the study, factors affecting enterprises hedging decisions include: to what degree that Chinese enterprises believe hedging leads to business stability; whether these enterprises had attended a hedge training or seminar; perceived price volatility in the market; and have alternative strategies to reduce price risks.
Practical implications
Agribusiness assistance programs can use this paper's findings to plan effective hedge training to help improve participation of futures hedging.
Originality/value
This study analyzes Chinese agribusiness firms' hedging behaviour, using a new set of questionnaire data collected from main agribusinesses. Chinese agribusiness firms' hedging behavior has not been fully examined. This study fills this gap.
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This paper provides a critique of minimum variance hedging using futures. The paper develops the conventional minimum variance hedge ratio (MVHR) and discusses its estimation. A…
Abstract
This paper provides a critique of minimum variance hedging using futures. The paper develops the conventional minimum variance hedge ratio (MVHR) and discusses its estimation. A review of the wide variety of alternative methods used to construct MVHRs is then performed. These methods highlight many of the potential limitations in the conventional framework. The paper argues that the literature should focus more on the assumptions underlying the conventional MVHR, rather than improving the techniques used to estimate the conventional MVHR.
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