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A Futures Duration-Convesity Hedging Method

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  • Daigler, Robert T
  • Copper, Mark

Abstract

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. Copyright 1998 by MIT Press.

Suggested Citation

  • Daigler, Robert T & Copper, Mark, 1998. "A Futures Duration-Convesity Hedging Method," The Financial Review, Eastern Finance Association, vol. 33(4), pages 61-80, November.
    • Handle: RePEc:bla:finrev:v:33:y:1998:i:4:p:61-80
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    Cited by:

    1. Bessler, Wolfgang & Wolff, Dominik, 2014. "Hedging European government bond portfolios during the recent sovereign debt crisis," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 33(C), pages 379-399.

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