Complex hedges: How well do they work?

Abstract

his paper examines empirically whether complex hedges reduce risk more than T naive or simple hedges? Danthine (1980,1981) derived two of the complex hedges we study. They extended a simple hedging model by introducing hedges in multiple assets and hedges of portfolios of assets. Baesel and Grant (1982) developed the third complex strategy by including trading at multiple dates.Ederington (1979) and others show that the simple hedge is the expected value of a regression coefficient. The dependent variable is the spot position. The independent variable is the futures price. Baesel and Grant examined trading in a different contract at each of two dates. Their results extend to trading in multiple contracts at many dates. The variance-minimizing hedges are the expected values of a vector of regression coefficients. The dependent variable is always a "properly defined" spot position. The independent variables are the futures prices. The "properly defined" spot position at each trading date is the asset being hedged plus the stochastic returns from futures positions at later dates.* This paper examines the empirical value of these complex hedges which are based on more realistic assumptions. For example, the number of assets traded in futures markets is small relative to those traded in spot markets. Therefore, many potential hedgers will 'A naive hedge is a one-to-one futures position in the same asset. A simple hedge is a risk-minimizing fu%e authors will provide on request a unified derivation of a11 of the complex hedges tested in this paper.

The risk management effectiveness of multivariate hedging models in the U.S. soy complex

“…This is consistent with the previous evaluation of other complex hedging strategies done by Grant and Eaker (1989). (ii) In addition, there is not even any evidence to support using the univariate risk-minimizing model of Ederington over the equal and opposite hedge.…”

“…This further emphasizes the need for testing. Grant and Eaker (1989) did a very thorough and careful job of testing a group of complex hedging strategies. Most importantly, they tested all the models with out-of-sample data.…”

The impact of the lengths of estimation periods and hedging horizons on the effectiveness of a Hedge: Evidence from foreign currency futures

“…It is important to note that the effectiveness of the ex ante and the ex post methodologies are not comparable. Grant and Eaker (1989) propose a variance reduction measure to compare complex hedging strategies. This study is not interested in a direct comparison of expost and ex ante hedging.…”

Hedge ratios and basis behavior: An intuitive insight?

“…A forecast price increase would suggest reduced short hedging, possible to the point of "a Texas hedge" and vice versa [Miller (1986)l. While Grant and Eaker (1989) suggest that too much emphasis has been placed on complex hedges, including the estimation of hedge ratios, perhaps effort may be well spent on basis forecasting models and costs of delivery [Garcia, Leuthold, and Sarkan (1984); Naik and Leuthold (1991); Tilley and Campbell (1988)l. Nevertheless, incorporating basis behavior to forecast the net price expected from a hedge may be useful.…”