Fractional cointegration and futures hedging

This article examines the performance of various hedge ratios estimated from different econometric models: The FIEC model is introduced as a new model for estimating the hedge ratio. Utilized in this study are NSA futures data, along with the ARFIMA-GARCH approach, the EC model, and the VAR model. Our analysis identifies the prevalence of a fractional cointegration relationship. The effects of incorporating such a relationship into futures hedging are investigated, as is the relative performance of various models with respect to different hedge horizons. Findings include: (i) Incorporation of conditional heteroskedasticity improves hedging performance; (ii) the hedge ratio of the EC model is consistently larger than that of the FIEC model, with the EC providing better post-sample hedging performance in the return–risk context; (iii) the EC hedging strategy (for longer hedge horizons of ten days or more) incorporating conditional heteroskedasticty is the dominant strategy; (iv) incorporating the fractional cointegration relationship does not improve the hedging performance over the EC model; (v) the conventional regression method provides the worst hedging outcomes for hedge horizons of five days or more. Whether these results (based on the NSA index) can be generalized to other cases is proposed as a topic for further research. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 457–474, 1999     

Optimal hedging with futures options

This paper explores the use of commodity options as risk management tools in incomplete markets with particular attention to alternative hedging strategies in the presence of basis and quantity risks. Hedgers typically face basis and quantity risks, which result in incomplete markets. In such markets, portfolios of commodity options prove a viable means of managing risks.Hedging opportunities are characterized using partial equilibrium frameworks, comparative statics, and an illustration from a simulation. A nonlinear optimization technique determines optimal portfolios of commodity options. All models examined are static two-date models. Therefore, they ignore the dynamic aspects of the hedger's problem, and distinguish neither American from European options, nor futures from forward markets.     

Flexible covariance dynamics,high-frequency data,and optimal futures hedging

This paper investigates the out-of-sample performance of hedged portfolios constructed using a novel rotated ARCH (RARCH) model class, which enables flexible covariance dynamics for spot and futures returns. The model's empirical fit can be significantly improved when it incorporates rotated realized covariance matrix measures. The empirical results suggest that a highly risk-averse hedger implementing the restricted RARCH model would be willing to pay substantial switching fees to capture the incremental gains generated by the flexible and informative alternative; this thus supports the economic importance of incorporating high-frequency data into flexible RARCH modeling processes for the construction of optimal hedged portfolios.     

A hedging deficiency in eurodollar futures

The eurodollar futures contract of the Chicago Mercantile Exchange is arguably the most successful of all futures contracts. The contract is structured such that its price does not converge to the price of the underlying eurodollar time deposit. Ignoring the daily settlement, one typically assumes that a eurodollar futures contract perfectly hedges an anticipated loan pegged to LIBOR, provided the loan rate is set at the eurodollar expiration. This article demonstrates that this hedge is not perfect, leaving a risk empirically estimated at four basis points, a seemingly small amount but considerably larger than the bid–ask spread on the futures. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:189–207, 2006     

Spot‐futures spread,time‐varying correlation,and hedging with currency futures

This article investigates the effects of the spot‐futures spread on the return and risk structure in currency markets. With the use of a bivariate dynamic conditional correlation GARCH framework, evidence is found of asymmetric effects of positive and negative spreads on the return and the risk structure of spot and futures markets. The implications of the asymmetric effects on futures hedging are examined, and the performance of hedging strategies generated from a model incorporating asymmetric effects is compared with several alternative models. The in‐sample comparison results indicate that the asymmetric effect model provides the best hedging strategy for all currency markets examined, except for the Canadian dollar. Out‐of‐sample comparisons suggest that the asymmetric effect model provides the best strategy for the Australian dollar, the British pound, the deutsche mark, and the Swiss franc markets, and the symmetric effect model provides a better strategy than the asymmetric effect model in the Canadian dollar and the Japanese yen. The worst performance is given by the naïve hedging strategy for both in‐sample and out‐of‐sample comparisons in all currency markets examined. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:1019–1038, 2006     

Pricing and hedging in the freight futures market

In this article, we consider the pricing and hedging of single‐route dry bulk freight futures contracts traded on the International Maritime Exchange. Thus far, this relatively young market has received almost no academic attention. In contrast to many other commodity markets, freight services are non‐storable, making a simple cost‐of‐carry valuation impossible. We empirically compare the pricing and hedging accuracy of a variety of continuous‐time futures pricing models. Our results show that the inclusion of a second stochastic factor significantly improves the pricing and hedging accuracy. Overall, the results indicate that the Schwartz and Smith ( 2000 ) two‐factor model provides the best performance. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:440–464, 2011     

Liquidity constraints and the hedging role of futures spreads

This paper examines the behavior of the competitive firm under price uncertainty in general and the hedging role of futures spreads in particular. The firm has access to a commodity futures market where unbiased nearby and distant futures contracts are transacted. A liquidity constraint is imposed on the firm such that the firm is forced to prematurely close its distant futures position whenever the net interim loss due to its nearby and distant futures positions exceeds a threshold level. This paper shows that the liquidity constrained firm optimally opts for a long nearby futures position and a short distant futures position should the firm be prudent, thereby rendering the optimality of using futures spreads for hedging purposes. This paper further shows that the firm's production decision is adversely affected by the presence of the liquidity constraint. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:909–921, 2004     

A note on asymmetric stochastic volatility and futures hedging

This note incorporates asymmetric responses to good and bad news within a stochastic volatility framework. It is shown that the asymmetry leads to a greater average optimal hedge ratio. Moreover, the ratio increases with increasing degree of asymmetry. On the other hand, asymmetry has no impact on the hedging performance. The result is consistent with the empirical finding of Brooks, Henry, and Persand (2002) where GARCH models are employed. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:607–612, 2005