Hedging

Omotoyosi Van Wie.

Hedging your Advice: Do Portfolio Models Explain Hedging?

Introduction- Anne Peck and Antoinette Nahmias study the effectiveness of using standard portfolio models to explain Hedging strategies in futures market.

The objective of the paper is to analyze hedging behavior using long time series of reported cash and futures market positions of Millers national Federation (MNF). The study examines how well a standard portfolio model explains substantial variation in the extent to which MNF hedged net market positions with futures market.

The data used are summaries of average physical and futures markets positions between sub-periods of 1964-1971 and 1972-1979. The physical and futures market positions are end of quarter observations. Cash prices are taken from Kansas City Grain Marketing news. Future prices are taken from contracts traded in Kansas City Board of Trade.

Method - Price data are used to determine the optimal and minimum risk ratios of MNF according to the hedging ratio recommended in the portfolio model. The portfolio model ratios (optimal and minimum risk ratios) are compared to the actual hedging ratios observed by the firm in a joint test where both theory and empirical representations are analyzed. To estimate the observed ratios and the portfolio model ratios the authors use daily data on expected price changes based on past price behavior. Regressions are run on the recommended ratios and actual MNF hedging ratios.

Results-The average optimal ratio was the same as the actual ratio. There was no relation between the minimum risk ratio, the actual ratio and the optimal risk ratio. The values of R square from the regressions of recommended ratios and actual were negative. In accordance to the portfolio model, prices were significantly more variable in the later period and all the price risk was hedged in the later period. This is because actual ratio increased from 60% in the early period to...