Time-Discrete Hedging of Down-and-Out Puts with Overnight Trading Gaps

Hedging down-and-out puts (and up-and-out calls), where the maximum payoff is reached just before a barrier is hit that would render the claim worthless afterwards, is challenging. All hedging methods potentially lead to large errors when the underlying is already close to the barrier and the hedge portfolio can only be adjusted in discrete time intervals. In this paper, we analyze this hedging situation, especially the case of overnight trading gaps. We show how a position in a short-term vanilla call option can be used for efficient hedging. Using a mean-variance hedging approach, we calculate optimal hedge ratios for both the underlying and call options as hedge instruments. We derive semi-analytical formulas for optimal hedge ratios in a Black–Scholes setting for continuous trading (as a benchmark) and in the case of trading gaps. For more complex models, we show in a numerical study that the semi-analytical formulas can be used as a sufficient approximation, even when stochastic volatility and jumps are present.

Dynamic Conditional Bias-Adjusted Carry Cost Rate Futures Hedge Ratios

This paper proposes new dynamic conditional futures hedge ratios and compares their hedging performances along with those of common benchmark hedge ratios across three broad asset classes. Three of the hedge ratios are based on the upward-biased carry cost rate hedge ratio, where each is augmented in a different bias-mitigating way. The carry cost rate hedge ratio augmented with the dynamic conditional correlation between spot and futures price changes generally: (1) provides the highest hedging effectiveness and (2) has a statistically significantly higher hedging effectiveness than the other hedge ratios across assets, sub-periods, and rolling window sizes.

Religion vs ethics: hedge and safe haven properties of Sukuk and green bonds for stock markets pre- and during COVID-19

Purpose This study aims to examine the hedge and safe-haven properties of the Sukuk and green bond for the stock markets pre- and during the COVID-19 pandemic period. Design/methodology/approach To test the hedge and safe-haven characteristics of Sukuk and green bonds for stock markets, the study first uses the methodology proposed by Ratner and Chiu (2013). Next, the authors estimate the hedge ratios and hedge effectiveness of using Sukuk and green bonds in a portfolio with stock markets. Findings Strong safe-haven features of ethical (green) bonds reveal that adding green bonds into the investment portfolios brings considerable diversification avenues for the investors who tend to take fewer risks in periods of economic stress and turbulence. The hedge ratio and hedge effectiveness estimates reveal that green bonds provide sufficient evidence of the hedge effectiveness for various international stocks. Practical implications The study has significant implications for faith-based investors, ethical investors, policymakers and regulatory bodies. Religious investors can invest in Sukuk to relish low-risk and interest-free investments, whereas green investors can satisfy their socially responsible motives by investing in these investment streams. Policymakers can direct the businesses to include these diversifiers for portfolio and risk management. Originality/value The study provides novel insights in the testing hedge and safe-haven attributes of green bonds and Sukuk while using unique methodologies to identify multiple low-risk investors for investors following the uncertain COVID-19 pandemic.

Hedging the Price Risk Inherent in Revenue Protection Insurance

Crop revenue insurance is unique, because it involves a guarantee subsuming yield risk and highly systematic price risk. This study examines whether crop insurers could use options instead of, or in addition to, assigning policies to the Commercial Funds of the USDA Federal Crop Insurance Corporation (FCIC) as per the Standard Reinsurance Agreement (SRA) to hedge the price risk of revenue insurance policies. The behavioral model examines the optimal hedge ratio for a crop insurer with a book of business consisting of corn Revenue Protection (RP) policies. Results show that a mix of put and call options can hedge the price risk of the RP policies. The higher optimal hedge ratios of call options as compared to put options imply that the risk of increased liability due to upside price risk can be hedged using options better than downside price risk. This study also analyzed the combination of options with the SRA at 35, 50, and 75% retention levels. The zero optimal hedge ratios at each retention level and the negative correlation between RP indemnities and the option returns when the crop insurer mixed options and SRA suggest that the purchasing of options provides no additional risk protection to crop insurers beyond what is provided by the SRA despite retention limits.

Hedging Long-Dated Oil Futures and Options Using Short-Dated Securities—Revisiting Metallgesellschaft

Since the collapse of the Metallgesellschaft AG due to hedging losses in 1993, energy practitioners have been concerned with the ability to hedge long-dated linear and non-linear oil liabilities with short-dated futures and options. This paper identifies a model-free non-parametric approach to extrapolating futures prices and implied volatilities. When we expand the analysis to implementing hedge portfolios for long-dated futures or option contracts over the time period 2007–2017, we utilize the useful benchmark of hedge ratios arising from Schwartz and Smith. With respect to the empirical consequences of hedging long-dated futures and options with their short-dated counterparts, we find that the long-term tracking errors are, on average, quite close to zero, but there is increasing risk entailed in attempting to do so, as the hedge-tracking errors for both futures and option contracts increase with time-to-maturity.

Research on the Hedge Ratio of China's Crude Oil Futures — Based on DCC-GARCH Model

Crude oil plays an important role in economic development. This paper chooses China’s crude oil futures and crude oil actuals as the research objects, and builds the DCC-GARCH model to study the hedge ratio under the risk minimization standard. The hedge ratios obtained from the DCC-GARCH model will be compared with those obtained from OLS, B-VAR and VECM models. The empirical results prove that: China’s crude oil futures and actuals have a significant reverse “leverage effect”; China’s crude oil futures have a variance reduction of more than 70% under all models; the DCC-GARCH model achieves the best hedging performance in the four models.

Hedging stock market prices with WTI, Gold, VIX and cryptocurrencies: a comparison between DCC, ADCC and GO-GARCH models

PurposeIn a first place, the present paper is designed to examine the dynamic correlations persistent between five cryptocurrencies, WTI, Gold, VIX and four stock markets (SP500, FTSE, NIKKEI and MSCIEM). In a second place, it investigates the relevant optimal hedging strategy.Design/methodology/approachEmpirically, the authors examine how WTI, Gold, VIX and five cryptocurrencies can be applicable to hedge the four stock markets. Three variants of multivariate GARCH models (DCC, ADCC and GO-GARCH) are implemented to estimate dynamic optimal hedge ratios.FindingsThe reached findings prove that both of the Bitcoin and Gold turn out to display remarkable hedging commodity features, while the other assets appear to demonstrate a rather noticeable disposition to act as diversifiers. Moreover, the results show that the VIX turns out to stand as the most effectively appropriate instrument, fit for hedging the stock market indices various related refits. Furthermore, the results prove that the hedging strategy instrument was indifferent for FTSE and NIKKEI stock while for the American and emerging markets, the hedging strategy was reversed from the pre-cryptocurrency crash to the during cryptocurrency crash period.Originality/valueThe first paper's empirical contribution lies in analyzing emerging cross-hedge ratios with financial assets and compare hedging effectiveness within the period of crash and the period before Bitcoin crash as well as the sensitivity of results to refits choose to compare between short term hedging strategy and long-term one.

Did COVID-19 Impact the Connectedness Between Green Bonds and Other Financial Markets? Evidence From Time-Frequency Domain With Portfolio Implications

COVID-19 has morphed from a health crisis to an economic crisis that affected the global economy through several channels. This paper aims to study the impact of COVID-19 on the time-frequency connectedness between Green Bonds and other financial assets. Our sample includes the global stock market, bond market, oil, USD index, and two popular hedging alternatives, namely Gold and Bitcoin, from May 2013 to August 2020. First, we apply the methodologies of Diebold and Yilmaz (International Journal of Forecasting, 2012, 28(1), 57–66) and Baruník and Křehlík (Journal of Financial Econometrics, 2018, 16(2), 271–296). Then, we estimate hedge ratios and hedge effectiveness of green bonds for other financial assets. Green bonds are found to have a great weight in the overall network, particularly strongly connected with the USD index and bond index. While the bi-directional relationship with USD persists during COVID, the connectedness with conventional bonds is also strengthened. Notably, we find a weak relationship between Green bonds and Bitcoin, both in the short and long run. As portfolio implications, Gold and USD have the highest hedge ratio, which is confirmed by the hedging effectiveness. In contrast, oil and stocks exhibit the lowest hedging effectiveness. Our findings imply that financial assets might have a heterogeneous relationship with green bonds. Furthermore, despite its infancy, it seems that the role of green bond during a crisis should not be ignored, as it can be a hedger for some assets, while a contagion amplifier during crisis times.

Risk Spillover during the COVID-19 Global Pandemic and Portfolio Management

This paper aims to examine the volatility spillover, diversification benefits, and hedge ratios between U.S. stock markets and different financial variables and commodities during the pre-COVID-19 and COVID-19 crisis, using daily data and multivariate GARCH models. Our results indicate that the risk spillover has reached the highest level during the COVID-19 period, compared to the pre-COVID period, which means that the COVID-19 pandemic enforced the risk spillover between U.S. stock markets and the remains assets. We confirm the economic benefit of diversification in both tranquil and crisis periods (e.g., a negative dynamic conditional correlation between the VIX and SP500). Moreover, the hedging analysis exhibits that the Dow Jones Islamic has the highest hedging effectiveness either before or during the recent COVID19 crisis, offering better resistance to uncertainty caused by unpredictable turmoil such as the COVID19 outbreak. Our finding may have some implications for portfolio managers and investors to reduce their exposure to the risk in their portfolio construction.