Narrow Results

Macro-hedging is one of the most important issues in hedging, but there are very few studies on the welfare impact of macro-hedging. To bridge a gap in the literature of macro-hedging, this paper introduces a method that generalizes and extends existing models of macro-hedging in several significant ways. We first assume the existence of basis risk in a small country to hedge in futures markets instead of forward contracts and relax the full-hedging assumption. We use the quantity being hedged in futures contracts as a decision variable. We also relax the restrictive assumption regarding the form of the spot price. We then derive the formula to estimate the welfare gain which can be easily implemented in any empirical case. In contrast to quasi-simulation being used in some existing approaches, our proposed method can be used for any real data, including future data, but existing methods in the literature cannot. Our approach is for investors for their investment decision-making when they use macro-hedging as their trading strategy.

We study a series of static and dynamic portfolios of Volatility Index (VIX) futures and their effectiveness to track the VIX. We derive each portfolio using optimization methods, and evaluate its tracking performance from both empirical and theoretical perspectives. Among our results, we show that static portfolios of different VIX futures fail to track VIX closely. VIX futures simply do not react quickly enough to movements in the spot VIX. In a discrete-time model, we design and implement a dynamic trading strategy that adjusts daily to optimally track VIX. The model is calibrated to historical data and a simulation study is performed to understand the properties exhibited by the strategy. In addition, compared to the volatility ETN, VXX, we find that our dynamic strategy has a superior tracking performance.

In energy markets, changes in the spot price due to the influence of weather and seasonal demand conditions are partially predictable. In this work, we examine the German GASPOOL and NetConnect Germany natural gas markets using the Ederington and Salas [2008] framework that considers the predictive power of the base (futures price minus spot price) in the estimation of minimum variance hedge ratios. A considerable improvement in risk reduction and hedging effectiveness can be obtained by considering the partial predictability of changes in spot prices. We find that long hedges perform better than short hedges and there is no benefit to be gained by using more complex hedging estimations (BEKK) over the simpler OLS model. Seasonality is also found in hedging ratios.

Energy-based assets are showing increased susceptibility to volatility arising out of geo-political, economic, climate and technological events. Given the economic importance of energy products, their market participants need to be able to access efficient strategies to effectively manage their exposures and reduce price risk. This chapter will outline the key futures-based hedging approaches that have been developed for managing energy price risk and evaluate their effectiveness. A key element of this analysis will be the breadth of assets considered. These include Crude and Refined Oil products, Natural Gas and wholesale Electricity markets. We find significant differences in the hedging effectiveness of the different energy markets. A key finding is that, Natural Gas and particularly Electricity futures are relatively ineffective as a risk management tool when compared with other energy assets.

As the international financial marketplace has evolved to encompass a wide range of tradable asset classes, tensions between classical investment theory, trading practices, and government regulations have grown. This chapter will map the history of modern trading, taking a close look at the products, venues, and technological underpinnings of today's futures markets. It will focus on high-frequency trading, assessing the varying roles and needs of investment elites, market makers, regulators, and the public in maintaining clean and orderly market mechanisms. Key questions include the role of market participants, hedgers, speculators, and arbitrageurs in high-frequency trading and price discovery, their influence over fluctuations in financial stability, and the implications for the financial system as a whole. The chapter will conclude with a look ahead in terms of the regulatory activities that will shape these mechanisms in the years to come, with comments on market microstructure, the provision of liquidity, and innovation in futures markets around the world.