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EVALUATION OF HEDGE EFFECTIVENESS TESTS

Institute for Computer Science III, Hamburg University of Science and Technology, Schwarzenbergstr. 95, D–21073 Hamburg, Germany

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SIEGFRIED M. RUMP

Institute for Computer Science III, Hamburg University of Science and Technology, Schwarzenbergstr. 95, D–21073 Hamburg, Germany

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https://doi.org/10.1142/S021986810500029XCited by:4 (Source: Crossref)

Abstract

According to IAS 39 or FAS 133 an a posteriori test for hedge effectiveness has to be implemented when using hedge accounting. Both standards do not regulate which numerical method has to be used.

A number of hedge effectiveness tests have been published recently. Such tests are of different quality; for example, not all of them can deal with the problem of small numbers. This means a test might determine an effective hedge to be ineffective, a scenario which would increase the volatility in earnings. Therefore, it seems useful to have criteria at hand to discriminate and assess hedge effectiveness tests.

In this paper, we introduce such objective criteria, which we develop according to our understanding of miminum economic requirements. They are applicable to tests based on market values of two points in time as well as tests based on time series of market values.

According to our criteria we compare common tests like the dollar offset ratio, regression analysis or volatility reduction, showing strengths and weaknesses. Finally, we develop a new Adjusted Hedge Interval test based on our previous one (Hailer, AC and SM Rump (2003). Zeitschrift für das gesamte kreditwesen, 56(11), 599–603). Our test does not show weaknesses of other effectiveness tests.

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References

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EVALUATION OF HEDGE EFFECTIVENESS TESTS

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