Hedging Housing Risk*

An unusually rich source of data on housing prices in Stockholm is used to analyze the investment implications of housing choices. This empirical analysis derives market-wide price and return series for housing investment during a 13-year period, and it also provides estimates of the individual-specific, idiosyncratic, variation in housing returns. Because the idiosyncratic component follows an autocorrelated process, the analysis of portfolio choice is dependent upon the holding period. We analyze the composition of household investment portfolios containing housing, common stocks, stocks in real estate holding companies, bonds, and t-bills. For short holding periods, the efficient portfolio contains essentially no housing. For longer periods, low-risk portfolios contain 15 to 50 percent housing. These results suggest that there are large potential gains from policies or institutions that would permit households to hedge their lumpy investments in housing. We estimate the potential value of hedges in reducing risk to households, yet yielding the same investment returns. The value is surprisingly large, especially to poorer homeowners.     

盯市风险下的期货套期保值

本文把盯市风险引入传统的期货套期保值框架，论证了在考虑盯市风险的情况下，一个关注每日最大亏损值的套期保值者会显著地减少他的期货头寸。在一个中期的套期保值期内，该套期保值者的期货套期保值头寸约为其现货头寸的80％。盯市风险的影响随着套期保值期的延长而缓慢减弱。如果套期保值者关注的是每日平均亏损值，在一个中期的套期保值期内盯市风险的影响极小。     

An International Asset Pricing Model with Time-Varying Hedging Risk

This paper employs a two-factor international equilibrium asset pricing model to examine the pricing relationships among the world's five largest equity markets. In addition to the traditional market factor premium, a hedging factor premium is included as the second factor to explain the relationship between risks and returns in the international stock markets. Moreover, a GARCH parameterization is adopted to characterize the general dynamics of the conditional second moments. The results suggest that the additional hedging risk premium is needed to explain rates of return on international equities. Furthermore, the restriction that the coefficient on the hedge-portfolio covariance is one smaller than the coefficient on the market-portfolio covariance can not be rejected. This suggests that the intertemporal asset pricing model proposed by Campbell (1993) can be used to explain the returns on the five largest stock market indices.     

Hedging Corporate Bonds

We examine Treasury bond and stock index futures, the swap curve and two types of hypothetical corporate bond assets as alternative hedging instruments for portfolios of corporate bonds. Conducting ex post and ex ante tests we find evidence that credit quality and maturity are important sources of basis risk when hedging corporate bonds whose credit rating are below triple A. We conclude that a new corporate hedging instrument may be useful for those wishing to hedge corporate bond portfolios provided that transaction costs are not too high relative to existing futures contracts.     

Managerial Ownership and Corporate Hedging

Abstract:  Using information on 443 UK non-financial companies, this work provides evidence supporting the hypothesis that managerial risk aversion is an incentive to deviate from the optimal hedging position. Conflicts of interest between shareholders and managers are at the centre of the decision about the firm's risk profile but are not relevant as determinants of the decision to hedge. This is rather associated with factors enhancing the firm's expected value (underinvestment, scale economies, tax savings).     

Methods of Partial Hedging

In this article we survey methods of dealing with the following problem: A financial agent is trying to hedge a claim C, without having enough initial capital to perform a perfect (super) replication. In particular, we describe results for minimizing the expected loss of hedging the claim C both in complete and incomplete continuous-time financial market models, and for maximizing the probability of perfect hedge in complete markets and markets with partial information. In these cases, the optimal strategy is in the form of a binary option on C, depending on the Radon-Nikodym derivative of the equivalent martingale measure which is optimal for a corresponding dual problem. We also present results on dynamic measures for the risk associated with the liability C, defined as the supremum over different scenarios of the minimal expected loss of hedging C. This revised version was published online in August 2006 with corrections to the Cover Date.     

Benefits from Asia-Pacific Mutual Fund Investments with Currency Hedging

This study presents empirical evidence on the efficiency and effectiveness of hedging U.S.-based international mutual funds with an Asia-Pacific investment objective. The case for active currency risk management is examined for a passive and a selective hedge, which is constructed with currency futures in the major currencies. Both static and dynamic hedging models are used to estimate the risk-minimizing hedge ratio. The results show that currency hedging improves the performance of internationally diversified mutual funds. Such hedging is beneficial even when based on prior optimal hedge ratios. Further, efficiency gains from hedging, as measured by the percent change in the Sharpe Index, are greatest under a selective portfolio strategy that is implemented with an optimal constant hedge ratio.     

Deriving Optimal Portfolios for Hedging Housing Risk

Households that contemplate moving to different cities or trading up/down in the future are exposed to substantial housing risk. In order to mitigate this risk, we derive optimal portfolios using CME housing futures. Housing investment risk is hedged by selling housing futures amounting to the full value of the home. Housing consumption risk is hedged by buying housing futures in each city where the household might move. The size of the hedges depends on the probability of moving, on home values, and on labor income in each region. The hedging demands offset each other when the household intends to live in the same home indefinitely.     

Hedging derivatives with model error

The current derivatives pricing technology enables users to hedge derivatives with the underlying asset or any other traded derivative. In theory, there is no reason to prefer one hedging instrument to another. However, given model errors, this is not true. Imposing some simple assumptions on the structure of model errors, this paper shows that to maximize hedging accuracy, there is an ordering to the hedging instruments utilized. Holding constant market illiquidities, one should always hedge first with ‘like’ derivatives, next with derivatives one layer down the hierarchy of derivatives, and lastly using the underlying.     

Hedging effectiveness under conditions of asymmetry

We examine whether hedging effectiveness is affected by asymmetry in the return distribution by applying tail-specific metrics, for example, value at risk, to compare the hedging effectiveness of short and long hedgers. Comparisons are applied to a number of hedging strategies including OLS and both symmetric and asymmetric generalised autoregressive conditional heteroskedastic models. We apply our analysis to a dataset consisting of S&P500 index cash and futures containing symmetric and asymmetric return distributions chosen ex post. Our findings show that asymmetry reduces out-of-sample hedging performance and that significant differences occur in hedging performance between short and long hedgers.     

基于死亡率免疫理论的自然对冲有效性评估

为应对长寿风险对年金产品的影响,本文提出分段对冲策略,并以死亡率免疫和死亡率久期规则为理论基础探讨该策略的有效性问题。为避免传统久期匹配方法中参数估计误差的累积和传导,借助WinBUGS软件和贝叶斯Markov Chain Monte Carlo方法,在统一的计算框架下完成了死亡率预测、死亡率久期计算和对冲效果的数值模拟;并以4种分段组合准备金数据的三维图、方差缩减比(VRR)和VaR值为指标进行长寿风险对冲有效性的对比,结果表明低年龄寿险保单和高年龄年金保单组合具有最平滑的三维图,最小的VRR和VaR值,可明显提高长寿风险自然对冲的有效性。     

Optimal Hedging and the Partial Loss Offset Provision

In this paper, we examine how taxation affects the optimal hedging behaviour of an investor exposed to price risk under partial loss offset provision. In this regime, only part of the loss is refunded through the tax. As such, it implies a non-linearity in the taxation schedule. More specifically, we look at an individual endowed with some fixed quantity of a commodity and facing a price risk. The optimal hedging policy is derived. The comparative statics of a tightening of the PLO provision and a changing risk aversion are analysed. We show that the response of the optimal hedging policy to a change in the tax rate can be signed by a preference free or a preference related sufficient condition, involving the notions of cost-of-carry and partial risk aversion.     

Neighborhood Diversity and House-Price Appreciation

This study examines changes in house prices relative to the level of and change in percent racial/ethnic composition for certain counties in Tampa and Orlando, Florida. Repeat-sales transactions between 1971 and 1997 are used to create a constant quality price index for each city. The index for Tampa shows that the average annual house price appreciation was 5.89 percent over the period 1970 through 1997. The index for Orlando shows that the average annual house price appreciation was 5.25 percent over the 1970 through 1997 period. When the Tampa index model is expanded to account for race/ethnicity, household factors, and economic factors, the level of African American population has no significant effect on house-price appreciation; however, the change in percent African American has a negative effect. The level of percent Hispanic population has a positive effect, and the change in percent Hispanic has a positive effect. The expanded Orlando model shows that the level of percent African American population has no significant effect on price appreciation, while the change in percent African American has a negative effect. The level of Hispanic population has a positive effect, while the change in percent in Hispanic has a negative effect.     

Risk diversification gains from metropolitan housing assets

The study analyzes the roles of metropolitan housing assets in risk diversification by assessing intertemporal hedging demands for multi‐asset portfolios, which include metropolitan houses, REITs, stocks, bonds, and riskless assets. Investors substitute housing assets in high‐population MSAs with those in low‐population cities, and they switch their holdings of housing assets to less risky bonds in the 2007–2008 housing bust. The findings from the multi‐period portfolio choice problem provide evidence for momentum reversal since forward‐looking investors substitute bottom metropolitan housing assets for top ones in the housing boom, and the GTTB index and the lagged REIT price return have negative impacts on various asset returns.     

Evaluating the Usefulness of the American Housing Survey for Creating House Price Indices

The American Housing Survey (AHS) is a valuable source of information on houses and occupants over time. The AHS has several advantages over sales data for use in the creation of price indices: it is readily available, has frequent observations over time and space, has data from the late 1970s through the mid-1990s, includes houses that do not sell, as well as those that do, and has information on the occupants. The drawbacks include: a time lag between the interview and the release of the data, data suppression issues, owner-stated house values, and a lack of neighborhood information. In this study, we use the metropolitan version of the AHS, which has been supplemented with the original survey data as well as Census tract data for three cities over 14 years to examine whether the AHS can be used to create indices. Indices are estimated using hedonic, repeat valuation, and hybrid techniques, overcoming some of the problems inherent in the estimation of indices. We find that the data-suppression issues and the owner-stated house values are not problematic. The biggest drawback of the AHS is its lack of objective information on neighborhood quality.     

A Futures Duration-Convexity Hedging Method

A duration-based hedge ratio is the conventional method to hedge against price changes of a fixed-income instrument. However, the relationship between bond prices and interest rates is nonlinear, creating a convexity effect. Moreover, term structure changes often are nonparallel in nature, which causes imperfect hedges for the duration-based hedging model. One solution to these problems is to dynamically change the duration-based hedge ratio; however, this procedure is costly and is not effective when jumps in prices occur. A superior solution is to develop a two-instrument hedge ratio that simultaneously hedges both duration and convexity effects. This paper first presents such a two-instrument hedge ratio and then we examine its effectiveness. The simulation results show that this duration-convexity hedge ratio is vastly superior to alternative hedge ratio methods for both simple and complex changes in the term structure.     

Currency Hedging Using the Mean-Gini Framework

The mean-Gini framework has been suggested as a robust alternative to the portfolio approach to futures hedging given its optimality under general distributional conditions. However, calculation of the Gini hedge ratio requires estimation of the underlying price distribution. We estimate minimum-Gini hedge ratios using two widely-used estimation procedures, the empirical distribution function method and the kernel method, for three emerging market and three developed market currencies. We find that these methods yield different Gini hedge ratios. These differences increase with risk aversion and are statistically significant for all developed market currencies but only one emerging market currency. In-sample analyses show that the empirical distribution function method is more effective at risk reduction than the kernel method for developed market currencies, whereas the kernel method is superior for emerging market currencies. Post-sample analyses strengthen the superiority of the empirical distribution function method for developed market and, in several cases, for emerging market currencies.JEL Classification: F31, G15     

Hedging errors with Leland's option model in the presence of transaction costs

Nonzero transaction costs invalidate the Black–Scholes [1973. Journal of Political Economy 81, 637–654] arbitrage argument based on continuous trading. Leland [1985. Journal of Finance 40, 1283–1301] developed a hedging strategy which modifies the Black–Scholes hedging strategy with a volatility adjusted by the length of the rebalance interval and the rate of the proportional transaction cost. Kabanov and Safarian [1997. Finance and Stochastics 1, 239–250] calculated the limiting hedging error of the Leland strategy and pointed out that it is nonzero for the approximate pricing of an European call option, in contradiction to Leland's claim. As a further contribution, we first identify the mathematical flaw in the argument of Leland's claim and then quantify the expected percentage of hedging losses in terms of the hedging frequency and the level of the option strike price.     

Multiperiod Strip Hedging of Forward Commitments

This paper empirically compares two multiperiod hedging strategies—a strip hedge and a stack-and-roll hedge—to hedge a forward commitment. The multiperiod strip hedge is found to outperform the stack-and-roll hedge when forward prices are subject to multiple sources of price uncertainty and to perform no better when only one source of uncertainty is present. Moreover, the relative superiority of the strip hedge increases with the presence of multiple sources of uncertainty. Last, the strip hedge is found to be more costly to trade than the stack-and-roll hedge; however, its cost varies directly with its superiority at reducing risk.