International tenders and futures hedging

This paper examines the optimal bidding and hedging decisions of a risk‐averse firm that takes part in an international tender. The firm faces multiple sources of uncertainty: exchange rate risk, risk of an unsuccessful tender, and business risk. The firm is allowed to trade unbiased currency futures contracts to imperfectly hedge its contingent foreign exchange risk exposure. We show that the firm shorts less (more) of the unbiased futures contracts when its marginal utility function is convex (concave) as compared with the case that the marginal utility function is linear. We further show that the curvature of the marginal utility function plays a decisive role in determining the impact of currency futures hedging on the firm's bidding behavior. Sufficient conditions that ensure the firm bids more or less aggressively than in the case without hedging opportunities are derived. Copyright © 2006 John Wiley & Sons, Ltd.     

Corporate hedging and input price risk

Input price variability is an important source of risk for corporations that process raw commodities. Models of optimal input hedging are developed in this paper based on the maximization of managerial expected utility. The relationship between hedging strategies and output decisions is examined to assess the impact of the ability to set output prices on futures market participation. As a firm's ability to set output prices diminishes in the short run, input futures positions increase although the optimal hedge ratio may either increase or decrease. For a perfectly competitive firm, however, shifts in output price caused by input price changes provide a natural cash market hedge of input price risk and reduce the firm's optimal input futures position.     

Optimal full-hedging under state-dependent preferences

This paper examines the hedging behavior of a risk-averse individual who faces uncertainty in spot-market prices and has a state-dependent utility function. The model demonstrates how risk aversion, state-dependency of preferences, and dependence structure of spot-market prices and states of nature jointly determine the individual’s optimal hedge position. We stipulate two sets of necessary and sufficient conditions, one on the utility function and the other on the dependence structure of spot-market prices and states of nature, which yield the celebrated full-hedging theorem originally derived under state-independent preferences.     

Risk spillovers and portfolio management between developed and BRICS stock markets

This paper investigates spillover effects and portfolio diversification between the four major developed stock markets (USA, Europe, Japan and Asia) and five of the most important emerging stock markets known as the BRICS (Brazil, Russia, India, China and South Africa). To this end, we apply the multivariate DECO-FIEGARCH model to daily spot indices during the period 1998–2016. The results reveal a significant and asymmetric long memory process for both the developed and the BRICS markets. Moreover, we find a significant variability in the time-varying conditional correlations between the considered markets during both bull and bear markets, particularly from early 2007 to summer 2008. Additionally, we analyze the optimal portfolio weights, time-varying hedge ratios and hedging effectiveness based on the estimates of the model. The results underline the importance of overweighting the optimal portfolios with stocks from the developed countries over those from the BRICS. Finally, we assess the practical implications for mixed developed-BRICS stock portfolios, based on finding strong evidence of diversification benefits and downside risk reductions that confirm the usefulness of using developed market stocks in the BRICS stock portfolio risk management.     

Some Recent Developments in Futures Hedging

The use of futures contracts as a hedging instrument has been the focus of much research. At the theoretical level, an optimal hedge strategy is traditionally based on the expected–utility maximization paradigm. A simplification of this paradigm leads to the minimum–variance criterion. Although this paradigm is quite well accepted, alternative approaches have been sought. At the empirical level, research on futures hedging has benefited from the recent developments in the econometrics literature. Much research has been done on improving the estimation of the optimal hedge ratio. As more is known about the statistical properties of financial time series, more sophisticated estimation methods are proposed. In this survey we review some recent developments in futures hedging. We delineate the theoretical underpinning of various methods and discuss the econometric implementation of the methods.     

Dynamic volatility transmission and portfolio management across major cryptocurrencies: Evidence from hourly data

This study used hourly data to examine the dynamic conditional correlations and hedging strategies in the main cryptocurrency markets: Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), and Ripple (XRP). Multivariate generalized autoregressive conditional heteroskedasticity family models provided evidence of significant positive dynamic conditional correlations among these markets. A weaker conditional correlation was observed for the LCT–XRP portfolio than for the BTC–ETH portfolio, which had the highest correlation value. The dynamic correlations intensified after the cryptocurrency crisis. The results of a portfolio risk analysis suggested that investors should hold less BTC than LTC, ETH, and XRP to minimize risk while maintaining consistent expected portfolio returns. Investors should hold less BTC than the other cryptocurrencies during a crisis. In addition, the cheapest hedge strategy is to hold long BTC and short XRP regardless of the period. Holding long BTC and short LTC was found to be the most expensive hedge strategy. Finally, the study showed that an optimally weighted diversified portfolio provides the greatest reduction in risk and downside risk for ETH and LTC. For XRP, portfolio hedging is the best mechanism for reducing risk.     

Dynamic spillover and connectedness between oil futures and European bonds

This paper examines the spillovers and connectedness between crude oil futures and European bond markets (EBMs) having different maturities. We also analyze the hedging effectiveness of crude oil futures-bond portfolios in tranquil and turbulent periods. Using the spillovers index of Diebold and Yilmaz (2012, 2014), we show evidence of time-varying spillovers between markets under investigations, which varies between 65% and 83%. Moreover, three-month, six-month, one-year, three-year and thirty-year bonds and crude oil futures are net receivers of risk from other markets, whereas the remaining bonds are net contributors of risk to the other markets. Crude oil futures receive more risk from long-term than short-term bonds. Moreover, the magnitude of risk transmission is low for the pre-crisis and economic recovery periods. Crude oil futures market contributes significantly to the risk of other markets during the oil crisis and Brexit period. A portfolio risk analysis shows that that most investments should be in oil rather than bonds (except the short-term bonds). The hedge ratio is sensitive to market conditions, where the cost of hedging increases during GFC and ESDC period. Finally, a crude oil futures-bond portfolio offers the best hedging effectiveness during the COVID-19 pandemic period.     

Cash Position, Credit Risk and Hedging

In choosing between forward and spot hedging, cash constrained and/or high credit risk firms are more likely to hedge foreign currency transactions forward than firms of greater quality. This arises because the cost of the levered component of a spot hedge is greater than the cost of the unlevered component and this premium increases with higher credit risk. For given cash and credit characteristics, importers are more (less) likely to hedge forward than exporters if transactions costs in the home security market are less (more) than the corresponding costs in the foreign security market.     

Hedging with the Nikkei index futures: The convential model versus the error correction model

This study estimates and compares the hedge ratios of the conventional and the error correction models using Japan's Nikkei Stock Average (NSA) index and the NSA index futures with different time intervals. Comparisons of out-of-sample hedging performance reveal that the error correction model outperforms the conventional model, suggesting that the hedge ratios obtained by using the error correction model do a better job in reducing the risk of the cash position than those from the conventional model. In addition, this paper evaluates the effects of temporal aggregation on hedge ratios. It is found that temporal aggregation has important effects on the hedge ratio estimates.     

Tax asymmetry and futures hedging under liquidity constraints

This paper examines the optimal futures hedging decision of a firm facing uncertain income that is subject to asymmetric taxation with no loss‐offset provisions. All futures contracts are marked to market and require interim cash settlement of gains and losses. The firm is liquidity constrained in that it is forced to prematurely close its futures position on which the interim loss incurred exceeds a threshold level. The liquidity risk created by the interim funding requirement of a futures hedge is shown to proffer the firm perverse incentives, thereby making an under‐hedge optimal. This under‐hedging result holds irrespective of whether the firm is risk neutral or risk averse. Copyright © 2005 John Wiley & Sons, Ltd.     

How can investors build a better portfolio in small open economies? Evidence from Asia’s Four Little Dragons

This study investigates the role of hedging and portfolio design among stocks, exchange rates, and gold in small open economies (SOEs) from 4 January 2000 to 31 March 2020. We adopt the trivariate dynamic conditional correlation-fractionally integrated asymmetric power ARCH model and unconditional quantile regression model, and our findings show that the hedging role of the U.S. dollar (USD) and gold against stocks differs under regular and extreme market conditions. The USD can act as a powerful hedge asset for stocks in regular market periods. Moreover, during the global financial crisis and COVID-19 outbreak, the safe-haven effect of gold becomes stronger for almost all stocks, whereas the USD can serve as a strong safe haven against stock markets of Korea, Taiwan, and Singapore when stock returns are extremely low. In terms of portfolio designing, we find that adding the USD and gold to portfolios improves their hedging effectiveness, and the optimally weighted stock-USD-gold portfolio is the best portfolio strategy, irrespective of referring to return or risk.     

沪深300股指期货动态套期保值比率模型估计及比较——基于修正的ECM-BGARCH(1,1)模型的实证研究

本文以沪深300股指期货的真实交易数据及沪深300指数为研究对象,在最小方差套期保值的基础上,建立了ECM-BGARCH(1,1)的沪深300股指期货对沪深300指数的动态套期保值模型。其具体特色是:与利用沪深300股指期货仿真交易数据相比,通过利用沪深300股指期货的真实数据得到的最优套期保值比率更具真实性;通过建立具有时变特征、含有自相关和条件异方差的动态BGARCH(1,1)模型,不但考虑了实证所用数据的实际特点,而且保证了套期保值比率预测的准确性;实证研究结果表明,该模型优于现有的套期保值模型。     

Crack spread hedging: accounting for time‐varying volatility spillovers in the energy futures markets

Crude oil, heating oil, and unleaded gasoline futures contracts are simultaneously analysed for their effectiveness in reducing price volatility for an energy trader. A conceptual model is developed for a trader hedging the ‘crack spread’. Various hedge ratio estimation techniques are compared to a Multivariate GARCH model that directly incorporates the time to maturity effect often found in futures markets. Modelling of the time‐variation in hedge ratios via the Multivariate GARCH methodology, and thus taking into account volatility spillovers between markets is shown to result in significant reductions in uncertainty even while accounting for trading costs. Copyright © 2002 John Wiley & Sons, Ltd.     

基于非线性相关的最小方差套期保值比率研究

在最小方差套期保值模型的基础上,提出了最小方差套期保值的期货与现货波动非线性对冲原理,利用非线性相关系数代替传统的线性相关系数,提高了套期保值比率的准确性。提出了套期保值的收益率波动预测原理,利用GARCH(1,1)预测期货收益率的方差,利用EWMA模型预测现货收益率的方差,解决了收益率在历史期和套期保值期间因收益率波动发生结构性变化所导致的套期保值效果失真的问题。实证研究结果表明,本研究的套期保值比率的有效性高于现有模型,应用本研究模型进行套期保值,可以有效规避现货价格风险。     

Equal risk pricing under convex trading constraints

In an incomplete market model where convex trading constraints are imposed upon the underlying assets, it is no longer possible to obtain unique arbitrage-free prices for derivatives using standard replication arguments. Most existing derivative pricing approaches involve the selection of a suitable martingale measure or the optimisation of utility functions as well as risk measures from the perspective of a single trader.We propose a new and effective derivative pricing method, referred to as the equal risk pricing approach, for markets with convex trading constraints. The approach analyses the risk exposure of both the buyer and seller of the derivative, and seeks an equal risk price which evenly distributes the expected loss for both parties under optimal hedging. The existence and uniqueness of the equal risk price are established for both European and American options. Furthermore, if the trading constraints are removed, the equal risk price agrees with the standard arbitrage-free price.Finally, the equal risk pricing approach is applied to a constrained Black–Scholes market model where short-selling is banned. In particular, simple pricing formulas are derived for European calls, European puts and American puts.     

International trade and hedging in economies in transition

This paper develops a general equilibrium framework to analyze risk management policies in economies in transition. By cross-hedging against real exchange rate risk exposures, these economies can increase their gains from international trade. We suggest that countries with emerging forward markets can gradually introduce the risk sharing markets, as limiting resources may prevent them from introducing complete hedging markets in the first place. Thus the growing demand for risk management instruments can be gradually met and it would be welfare enhancing. Economies in transition benefit when hedging devices are offered by financial markets, irrespective of whether the hedging instruments are de facto perfect or not.     

存在交易成本的权证避险策略实证研究

权证发行人在存在交易成本时对冲风险,若按照B—S理论进行动态连续避险操作,将造成巨大的交易成本,致使B-S动态连续避险不可行。因此存在交易成本时,对避险的操作都采用间断性避险。本文在统一均值方差框架下,系统全面的比较了存在交易成本的五种避险策略。在比例交易成本情形下,Whalley—Wilmott避险策略优于其他所有策略,当避险误差的标准差相同时该策略的交易成本最小;其次分别是delta固定避险带避险策略,基于标的资产价格变化的避险策略,Leland避险模型和间断的B—S避险策略。随着波动率σ上升,无风险利率γ下降,基于变动的避险策略相对于基于时间的策略优势更大。     

Risk spillovers between cryptocurrencies and traditional currencies and gold under different global economic conditions

This paper applies a Diagonal BEKK model to investigate the risk spillovers of three major cryptocurrencies to ten leading traditional currencies and two gold prices (Spot Gold and Gold Futures). The daily data used are from 7 August 2015 to 15 June 2020. The dataset is analyzed in its entirety and is also subdivided into four distinct subsets in order to study and compare the patterns of spillover effects during economic turmoil, such as the 2018 cryptocurrency crash and the COVID-19 pandemic. The results reveal significant co-volatility spillover effects between cryptocurrency and traditional currency or gold markets, especially during the whole sample period and amid the uncertainty raised by COVID-19. The capabilities of cryptocurrency are time-varying and related to economic uncertainty or shocks. There are significant differences between normal and extreme markets with regard to the capabilities of cryptocurrency as a diversifier, a hedge or a safe haven. We find the significant co-volatility spillover effects are asymmetric in most cases especially during the COVID-19 pandemic period, which means the negative return shocks have larger impacts on co-volatility than positive return shocks of the same magnitude. Evidently, cryptocurrencies and traditional currencies or gold can be incorporated into financial portfolios for financial market participants who seek effective risk management and also for optimal dynamic hedging purposes against economic turmoil and downward movements.     

Do cryptocurrencies provide better hedging? Evidence from major equity markets during COVID-19 pandemic

Using the five-minute interval price data of two cryptocurrencies and eight stock market indices, we examine the risk spillover and hedging effectiveness between these two assets. Our approach provides a comparative assessment encompassing the pre-COVID-19 and COVID-19 sample periods. We employ copula models to assess the dependence and risk spillover from Bitcoin and Ethereum to stock market returns during both the pre-COVID-19 and COVID-19 periods. Notably, the COVID-19 pandemic has increased the risk spillover from Bitcoin and Ethereum to stock market returns. The findings vis-à-vis portfolio weights and hedge effectiveness highlight hedging gains; however, optimal investments in Bitcoin and Ethereum have reduced during the COVID-19 pandemic, while the cost of hedging has increased during this period. The findings also confirm that cryptocurrencies cannot provide incremental gains by hedging stock market risk during the COVID-19 pandemic.     

A vector-autoregression analysis of credit and liquidity factor dynamics in US LIBOR and Euribor swap markets

We use a vector autoregressive approach to investigate the determinants of US Dollar LIBOR and Euribor swap spread variation during the 2007–2009 crisis in global credit and money markets. Using market-quoted yield and spread data from the highly liquid credit default swap (CDS) and overnight index swap (OIS) markets, we provide compelling empirical evidence that liquidity risk factor shocks have been the dominant drivers of the variation in swap spreads over this period. Our findings provide an explanation for the temporal differences that liquidity shocks have on swap spreads and provide a contemporary perspective on the dynamical interplay between credit-default and liquidity risk-factors in these markets. As all our risk-factor proxies are traded in liquid derivatives markets, our findings have implications for proprietary hedge fund traders hedging an exposure to swap-spread risk, for bank treasurers managing their liquidity requirements and for central bankers seeking to better understand the response of markets to their macroeconomic policy implementation and liquidity management actions. Indeed our markets-based analysis suggests that the European Central Bank (ECB) has underperformed relative to the Federal Reserve in terms of the differing levels of market confidence placed in its macroeconomic policy actions and remedial liquidity interventions during the period.