The Minimum Variance Hedge Ratio Under Stochastic Interest Rates
In an environment where interest rates are stochastic, we examine the case of a "pure" hedger endowed with a fixed position in a long term bond. In contrast to conventional wisdom according to which the difference between hedging through forward contracts and futures is immaterial, it turns out that the minimum variance hedge ratio using forwards comprises two terms instead of one only when using futures. The magnitude of the difference between the two hedge ratios may be important under some plausible assumptions. This result is due to the presence of additional interest rate risk that bears on the profit-and-loss statement associated with the forward position. This sheds some additional light on the respective features of forward and futures contracts written on interest rate-sensitive securities.
Volume (Year): 46 (2000)
Issue (Month): 5 (May)
|Contact details of provider:|| Postal: 7240 Parkway Drive, Suite 300, Hanover, MD 21076 USA|
Web page: http://www.informs.org/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Stephen Figlewski & Yoram Landskroner & William L. Silber, 1991. "Tailing the hedge: Why and how," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 11(2), pages 201-212, 04.
- Harrison, J. Michael & Pliska, Stanley R., 1981. "Martingales and stochastic integrals in the theory of continuous trading," Stochastic Processes and their Applications, Elsevier, vol. 11(3), pages 215-260, August.
- Duffie, Darrell & Jackson, Matthew O., 1990. "Optimal hedging and equilibrium in a dynamic futures market," Journal of Economic Dynamics and Control, Elsevier, vol. 14(1), pages 21-33, February.
- Duffie, Darrell & Stanton, Richard, 1992. "Pricing continuously resettled contingent claims," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 561-573.
- J. Michael Harrison & Stanley R. Pliska, 1981. "Martingales and Stochastic Integrals in the Theory of Continous Trading," Discussion Papers 454, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Ronald W. Anderson & Jean-Pierre Danthine, 1983. "The Time Pattern of Hedging and the Volatility of Futures Prices," Review of Economic Studies, Oxford University Press, vol. 50(2), pages 249-266.
- Poncet, Patrice & Portait, Roland, 1993. "Investment and hedging under a stochastic yield curve : A two-state-variable, multi-factor model," European Economic Review, Elsevier, vol. 37(5), pages 1127-1147, June.
- Brealey, R. A. & Kaplanis, E. C., 1995. "Discrete exchange rate hedging strategies," Journal of Banking & Finance, Elsevier, vol. 19(5), pages 765-784, August.
- Benninga, Simon & Protopapadakis, Aris, 1994. "Forward and Futures Prices with Markovian Interest-Rate Processes," The Journal of Business, University of Chicago Press, vol. 67(3), pages 401-21, July.
- Adler, Michael & Detemple, Jerome B, 1988. " On the Optimal Hedge of a Nontraded Cash Position," Journal of Finance, American Finance Association, vol. 43(1), pages 143-53, March.
- Cox, John C. & Ingersoll, Jonathan Jr. & Ross, Stephen A., 1981. "The relation between forward prices and futures prices," Journal of Financial Economics, Elsevier, vol. 9(4), pages 321-346, December.
- Richard, Scott F. & Sundaresan, M., 1981. "A continuous time equilibrium model of forward prices and futures prices in a multigood economy," Journal of Financial Economics, Elsevier, vol. 9(4), pages 347-371, December.
- Bjorn Flesaker, 1993. "Arbitrage free pricing of interest rate futures and forward contracts," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 13(1), pages 77-91, 02.
- Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
- Michael Adler & Jerome Detemple, 1988. "Hedging with futures in an intertemporal portfolio context," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 8(3), pages 249-269, 06.
- Breeden, Douglas T., 1984. "Futures markets and commodity options: Hedging and optimality in incomplete markets," Journal of Economic Theory, Elsevier, vol. 32(2), pages 275-300, April.
- Stulz, René M., 1984. "Optimal Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(02), pages 127-140, June.
- Lioui, Abraham & Poncet, Patrice, 1996. "Optimal hedging in a dynamic futures market with a nonnegativity constraint on wealth," Journal of Economic Dynamics and Control, Elsevier, vol. 20(6-7), pages 1101-1113.
- Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
When requesting a correction, please mention this item's handle: RePEc:inm:ormnsc:v:46:y:2000:i:5:p:658-668. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mirko Janc)
If references are entirely missing, you can add them using this form.