Cross-hedging It is the year 2000, and you work in risk management for an airline. You want to hedge the airline’s expos
Posted: Sat Feb 26, 2022 9:12 am
Cross-hedging It is the year 2000, and you work in risk
management for an airline. You want to hedge the airline’s exposure
to fluctuations in the price of jet fuel (your airline buys one
million gallons of jet fuel every month), but the company’s bylaws
restrict you to using exchange-traded futures for hedging, and
there is not a liquid market for jet fuel futures contracts.
Suppose you choose to hedge using futures in a closely-related
asset, heating oil.
Use the data from 1990 to 2000 to calculate the minimum-variance
hedge ratio (MVHR), ℎ ∗ . Look up the contract size for heating oil
futures contracts on the CME Group web site, also called Heating
Oil USLD (www.cmegroup.com), and determine the optimal number of
heating oil futures (round to the nearest whole number). Specify
whether your hedge position is long or short.
b) Use the optimal number of heating oil futures contracts
you found in (a) to calculate monthly changes in the value of your
hedged position over the period from 2001 to 2010. Calculate the
volatility of these changes. Repeat these steps using values of ℎ ∗
2 and 2ℎ ∗ to show that a hedge using ℎ ∗ produces the minimum
volatility in the changes in value of the hedged position.
c) Produce a frequency histogram comparing the sizes of the
fluctuations in your airline’s fuel cost (a) with the hedge from
part (a) in place, and (b) without a hedge. How do you interpret
the results? Was the hedge effective?
d) What do you think are the strengths and weaknesses of
this cross-hedging strategy? In what way(s) might you modify the
strategy to reduce the volatility of the hedged position you
calculated in (b)?
management for an airline. You want to hedge the airline’s exposure
to fluctuations in the price of jet fuel (your airline buys one
million gallons of jet fuel every month), but the company’s bylaws
restrict you to using exchange-traded futures for hedging, and
there is not a liquid market for jet fuel futures contracts.
Suppose you choose to hedge using futures in a closely-related
asset, heating oil.
Use the data from 1990 to 2000 to calculate the minimum-variance
hedge ratio (MVHR), ℎ ∗ . Look up the contract size for heating oil
futures contracts on the CME Group web site, also called Heating
Oil USLD (www.cmegroup.com), and determine the optimal number of
heating oil futures (round to the nearest whole number). Specify
whether your hedge position is long or short.
b) Use the optimal number of heating oil futures contracts
you found in (a) to calculate monthly changes in the value of your
hedged position over the period from 2001 to 2010. Calculate the
volatility of these changes. Repeat these steps using values of ℎ ∗
2 and 2ℎ ∗ to show that a hedge using ℎ ∗ produces the minimum
volatility in the changes in value of the hedged position.
c) Produce a frequency histogram comparing the sizes of the
fluctuations in your airline’s fuel cost (a) with the hedge from
part (a) in place, and (b) without a hedge. How do you interpret
the results? Was the hedge effective?
d) What do you think are the strengths and weaknesses of
this cross-hedging strategy? In what way(s) might you modify the
strategy to reduce the volatility of the hedged position you
calculated in (b)?