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Minimum variance cross hedging under mean‐reverting spreads, stochastic convenience yields, and jumps: Application to the airline industry

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  • Mark Bertus
  • Jonathan Godbey
  • Jimmy E. Hilliard

Abstract

Exchange traded futures contracts often are not written on the specific asset that is a source of risk to a firm. The firm may attempt to manage this risk using futures contracts written on a related asset. This cross hedge exposes the firm to a new risk, the spread between the asset underlying the futures contract and the asset that the firm wants to hedge. Using the specific case of the airline industry as motivation, we derive the minimum variance cross hedge assuming a two‐factor diffusion model for the underlying asset and a stochastic, mean‐reverting spread. The result is a time‐varying hedge ratio that can be applied to any hedging horizon. We also consider the effect of jumps in the underlying asset. We use simulations and empirical tests of crude oil, jet fuel cross hedges to demonstrate the hedging effectiveness of the model. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:736–756, 2009

Suggested Citation

  • Mark Bertus & Jonathan Godbey & Jimmy E. Hilliard, 2009. "Minimum variance cross hedging under mean‐reverting spreads, stochastic convenience yields, and jumps: Application to the airline industry," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 29(8), pages 736-756, August.
    • Handle: RePEc:wly:jfutmk:v:29:y:2009:i:8:p:736-756
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    Cited by:

    1. Cao, Min & Conlon, Thomas, 2023. "Composite jet fuel cross-hedging," Journal of Commodity Markets, Elsevier, vol. 30(C).
    2. Luo, Rui & Fortenbery, T. Randall, 2016. "Corporate Hedging In Incomplete Markets: A Solution Under Price Transmission," 2016 Annual Meeting, July 31-August 2, Boston, Massachusetts 235444, Agricultural and Applied Economics Association.
    3. Chau, Frankie & Kuo, Jing-Ming & Shi, Yukun, 2015. "Arbitrage opportunities and feedback trading in emissions and energy markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 36(C), pages 130-147.

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