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Book part
Publication date: 5 July 2012

John Cotter and Jim Hanly

We examine whether the hedging effectiveness of crude oil futures is affected by asymmetry in the return distribution by applying tail-specific metrics to compare the…

Abstract

We examine whether the hedging effectiveness of crude oil futures is affected by asymmetry in the return distribution by applying tail-specific metrics to compare the hedging effectiveness of both short and long hedgers. The hedging effectiveness metrics we use are based on lower partial moments (LPM), value at risk (VaR) and conditional value at risk (CVaR). Comparisons are applied to a number of hedging strategies including ordinary least square (OLS), and both symmetric and asymmetric GARCH models. We find that OLS provides consistently better performance across different measures of hedging effectiveness as compared with GARCH models, irrespective of the characteristics of the underlying distribution.

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Derivative Securities Pricing and Modelling
Type: Book
ISBN: 978-1-78052-616-4

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Article
Publication date: 8 October 2018

Aparna Prasad Bhat

The purpose of this paper is to ascertain the effectiveness of major deterministic and stochastic volatility-based option pricing models in pricing and hedging

Abstract

Purpose

The purpose of this paper is to ascertain the effectiveness of major deterministic and stochastic volatility-based option pricing models in pricing and hedging exchange-traded dollar–rupee options over a five-year period since the launch of these options in India.

Design/methodology/approach

The paper examines the pricing and hedging performance of five different models, namely, the Black–Scholes–Merton model (BSM), skewness- and kurtosis-adjusted BSM, NGARCH model of Duan, Heston’s stochastic volatility model and an ad hoc Black–Scholes (AHBS) model. Risk-neutral structural parameters are extracted by calibrating each model to the prices of traded dollar–rupee call options. These parameters are used to generate out-of-sample model option prices and to construct a delta-neutral hedge for a short option position. Out-of-sample pricing errors and hedging errors are compared to identify the best-performing model. Robustness is tested by comparing the performance of all models separately over turbulent and tranquil periods.

Findings

The study finds that relatively simpler models fare better than more mathematically complex models in pricing and hedging dollar–rupee options during the sample period. This superior performance is observed to persist even when comparisons are made separately over volatile periods and tranquil periods. However the more sophisticated models reveal a lower moneyness-maturity bias as compared to the BSM model.

Practical implications

The study concludes that incorporation of skewness and kurtosis in the BSM model as well as the practitioners’ approach of using a moneyness-maturity-based volatility within the BSM model (AHBS model) results in better pricing and hedging effectiveness for dollar–rupee options. This conclusion has strong practical implications for market practitioners, hedgers and regulators in the light of increased volatility in the dollar–rupee pair.

Originality/value

Existing literature on this topic has largely centered around either US equity index options or options on major liquid currencies. While many studies have solely focused on the pricing performance of option pricing models, this paper examines both the pricing and hedging performance of competing models in the context of Indian currency options. Robustness of findings is tested by comparing model performance across periods of stress and tranquility. To the best of the author’s knowledge, this paper is one of the first comprehensive studies to focus on an emerging market currency pair such as the dollar–rupee.

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Journal of Indian Business Research, vol. 11 no. 1
Type: Research Article
ISSN: 1755-4195

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Article
Publication date: 31 May 2007

Won Cheol Yun

This study empirically compares the hedging performances of the newly listed Japanese yen (JPY) and European euro (EUR) currency futures in the KRX relative to that of the…

Open Access

Abstract

This study empirically compares the hedging performances of the newly listed Japanese yen (JPY) and European euro (EUR) currency futures in the KRX relative to that of the us dollar (USD) currency futures. For this purpose, assuming the situation of foreign-asset investment the minimum variance hedging models based on OLS and ECM are compared with a simple 1: 1 hedge. The difference between previous studies and this one is in that the latter uses various kinds of hedging performance measures and analyzes the hedging performances by different hedging horizon. According to the empirical results, the USD currency futures outperforms the JPY and EUR currency futures when considering the risk only.

However, the results are reversed wilen incorporating the return as well as the risk. With respect to the comparative advantages among hedging types, the ECM-hedge turns out to be better than the others for evaluating the risk only, and the 1: 1 hedge proves to be superior to the others when considering both of the return and risk aspects. Based on the risk-reduction aspect. the hedging performances are gradually improving as the length of hedging period increases, while they deteriorate for considering both the return and risk aspects.

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Journal of Derivatives and Quantitative Studies, vol. 15 no. 1
Type: Research Article
ISSN: 2713-6647

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Article
Publication date: 1 March 2002

ROBERT G. TOMPKINS

The depth and breadth of the market for contingent claims, including exotic options, has expanded dramatically. Regulators have expressed concern regarding the risks of…

Abstract

The depth and breadth of the market for contingent claims, including exotic options, has expanded dramatically. Regulators have expressed concern regarding the risks of exotics to the financial system, due to the difficulty of hedging these instruments. Recent literature focuses on the difficulties in hedging exotic options, e.g., liquidity risk and other violations of the standard Black‐Scholes model. This article provides insight into hedging problems associated with exotic options: 1) hedging in discrete versus continuous time, 2) transaction costs, 3) stochastic volatility, and 4) non‐constant correlation. The author applies simulation analysis of these problems to a variety of exotics, including Asian options, barrier options, look‐back options, and quanto options.

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The Journal of Risk Finance, vol. 3 no. 4
Type: Research Article
ISSN: 1526-5943

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Article
Publication date: 7 August 2007

Raimond Maurer and Shohreh Valiani

This study seeks to examine the effectiveness of controlling the currency risk for international diversified mixed‐asset portfolios via two different hedge instruments…

Abstract

Purpose

This study seeks to examine the effectiveness of controlling the currency risk for international diversified mixed‐asset portfolios via two different hedge instruments, currency forwards and currency options. So far, currency forward has been the most common hedge tool, which will be compared here with currency options to control the foreign currency exposure risk. In this regard, several hedging strategies are evaluated and compared with one another.

Design/methodology/approach

Owing to the highly skewed return distributions of options, the application of the traditional mean‐variance framework for portfolio optimization is doubtful. To account for this problem, a mean lower partial moment model is employed. An in‐the‐sample as well as an out‐of‐the sample context is used. With in‐sample analyses, a block bootstrap test has been used to statistically test the existence of any significant performance improvement. Following that, to investigate the consistency of the results, the out‐of‐sample evaluation has been checked. In addition, currency trends are also taken into account to test the time‐trend dependence of currency movements and, therefore, the relative potential gains of risk‐controlling strategies.

Findings

Results show that European put‐in‐the‐money options have the potential to substitute the optimally forward‐hedged portfolios. Considering the composition of the portfolio in using in‐the‐money options and forwards shows that using any of these hedge tools brings a much more diversified selection of stock and bond markets than no hedging strategy. The optimal option weights imply that a put‐in‐the‐money option strategy is more active than at‐the‐money or out‐of‐the‐money put options, which implies the dependency of put strategies on the level of strike price. A very interesting point is that, just by dedicating a very small part of the investment in options, the same amount of currency risk exposure can be hedged as when one uses the optimal forward hedging. In the out‐of‐sample study, the optimally forward‐hedged strategy generally presents a much better performance than any types of put policies.

Practical implications

The research shows the risk and return implications of different currency hedging strategies. The finding could be of interest for asset managers of internationally diversified portfolios.

Originality/value

Considering the findings in the out‐of‐sample perspective, the optimally forward‐hedged minimum risk portfolio dominates all other strategies, while, in the depreciation of the local currency, this, together with the forward‐hedged tangency portfolio selection, would characterize the dominant portfolio strategies.

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Managerial Finance, vol. 33 no. 9
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 8 December 2020

Yun Feng and Yan Cui

The purpose of this paper is to deeply study and compare the dual and single hedging strategy, from the direct and cross hedging perspective.

Abstract

Purpose

The purpose of this paper is to deeply study and compare the dual and single hedging strategy, from the direct and cross hedging perspective.

Design/methodology/approach

The authors not only first consider the dual hedge of integrated risks in this oil prices and foreign exchange rates setting but also make a novel comparison between the dual and single hedging strategy from a direct and cross hedging perspective. In total, six econometric models (to conduct one-step-ahead out-of-sample rolling estimation of the optimal hedge ratio) and two hedging performance criteria are employed in two different hedging backgrounds (direct and cross hedging).

Findings

Results show that in the direct hedging background, a dual hedge cannot outperform the single hedge. But in the cross dual hedging setting, a dual hedge performs much better, possibly because the dual hedge brings different levels of advantages and disadvantages in the two different settings and the superiority of the dual hedge is more obvious in the cross dual hedging setting.

Originality/value

The existing literature that deals with oil prices and foreign exchange rates mostly concentrates on their relationship and comovements, while the dual hedge of integrated risks in this setting remains underresearched. Besides, the existing literature that deals with dual hedge gets its conclusions only based on a single specific background (direct or cross hedging) and lacks deeper investigation. In this paper, the authors expand the width and depth of the existing literature. Results and implications are revealing.

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China Finance Review International, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 2044-1398

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Article
Publication date: 30 November 2003

Gyu Hyeon Mun and Jeong Hyo Hong

This paper studies hedging strategies that use the KOSDAQ50 index futures to hedge the price risk of the KOSDAQ50 index spot portfolio. This study uses the minimum…

Open Access

Abstract

This paper studies hedging strategies that use the KOSDAQ50 index futures to hedge the price risk of the KOSDAQ50 index spot portfolio. This study uses the minimum variance hedge model and bivariate ECT-GARCH (1,1) model as hedging models, and analyzes their hedging performances. The sample period covers from January 31, 2001 to December 31, 2002. The most important findings may be summarized as follows. First, both the risk-minimization and GARCH model exhibit hedge ratios that are substantially lower than one. Hedge ratios of the risk-minimization tend to be higher than those of GARCH model. Second, for the in-sample data, hedging effectiveness of GARCH model is higher than that of the risk-minimization, while for the out-of-sample data, hedging effectiveness of the risk-minimization with constant hedge ratios is not far behind the GARCH model in its hedging performance. Third, the hedging performance of KOSDAQ50 index futures is lower than that of KOSPI200 index futures, but higher than that of KTB futures. In conclusion, in the KOSDAQ50 index market, investors are encouraged to use the simple risk-minimization model to hedge the price risk of KOSDAQ50 spot portfolios.

Details

Journal of Derivatives and Quantitative Studies, vol. 11 no. 2
Type: Research Article
ISSN: 2713-6647

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Article
Publication date: 20 April 2012

Daniel Obereiner and Björn‐Martin Kurzrock

This paper seeks to shed light on the question whether German real estate investment vehicles provide an effective hedge against inflation. To do so it aims to investigate…

Abstract

Purpose

This paper seeks to shed light on the question whether German real estate investment vehicles provide an effective hedge against inflation. To do so it aims to investigate open‐end real estate funds, special funds and real estate stocks.

Design/methodology/approach

Traditional approaches as well as cointegration and causality tests are applied to monthly and quarterly index data from 1992:04 to 2009:12 for the subject investment vehicles.

Findings

There is strong evidence that real estate returns are almost independent from inflation in the short run. None of the investigated investment vehicles provide a hedge against expected and unexpected inflation at different lags. In contrast, cointegration tests show that real estate stocks, open‐end funds and special funds do provide a hedge against inflation in the long term. Likewise, causality tests suggest that real estate performance is influenced by inflation in the long term.

Research limitations/implications

The study still could not investigate closed‐end funds and G‐REITs. Yet, it does capture the most and comprehensive part of the indirect German real estate investment market.

Practical implications

Inflation‐hedging capabilities are of particular interest in periods of economic instability. Especially institutional investors with large asset portfolios seek to adjust their asset allocation to changing conditions.

Originality/value

To date, research papers on the subject of inflation‐hedging capabilities of real estate almost exclusively focus on REITs in the USA and in the UK. Research about the German real estate market and alternative investment vehicles is rare – partly due to a lack of transparency over the past – although international investors more and more adhere to the German real estate investment market.

Details

Journal of Property Investment & Finance, vol. 30 no. 3
Type: Research Article
ISSN: 1463-578X

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Book part
Publication date: 19 June 2019

Yayun Yan and Sampan Nettayanun

Our study explores friction costs in terms of competition and market structure, considering factors such as market share, industry leverage levels, industry hedging

Abstract

Our study explores friction costs in terms of competition and market structure, considering factors such as market share, industry leverage levels, industry hedging levels, number of peers, and the geographic concentration that influences reinsurance purchase in the Property and Casualty insurance industry in China. Financial factors that influence the hedging level are also included. The data are hand collected from 2008 to 2015 from the Chinese Insurance Yearbook. Using panel data analysis techniques, the results are interesting. The capital structure shows a significant negative relationship with the hedging level. Group has a negative relationship with reinsurance purchases. Assets exhibit a negative relationship with hedging levels. The hedging level has a negative relation with the individual hedging level. Insurers have less incentive to hedge because it provides less resource than leverage. The study also robustly investigates the strategic risk management separately by the financial crises.

Content available
Article
Publication date: 31 August 2013

Byungwook Choi

The purpose of this study is to investigate hedging effectiveness of KOSPI200 index futures and options using three measures proposed by Fishburn (1977), Ederington…

Open Access

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.

Details

Journal of Derivatives and Quantitative Studies, vol. 21 no. 3
Type: Research Article
ISSN: 2713-6647

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