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Minimum variance cross hedging under mean‐reverting spreads, stochastic convenience yields, and jumps: Application to the airline industry
Author(s) -
Bertus Mark,
Godbey Jonathan,
Hilliard Jimmy E.
Publication year - 2009
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.20379
Subject(s) - futures contract , asset (computer security) , basis risk , hedge , econometrics , economics , mean reversion , variance (accounting) , financial economics , risk premium , actuarial science , capital asset pricing model , computer science , ecology , computer security , accounting , biology
Abstract Exchange traded futures contracts often are not written on the specific asset that is a source of risk to a firm. The firm may attempt to manage this risk using futures contracts written on a related asset. This cross hedge exposes the firm to a new risk, the spread between the asset underlying the futures contract and the asset that the firm wants to hedge. Using the specific case of the airline industry as motivation, we derive the minimum variance cross hedge assuming a two‐factor diffusion model for the underlying asset and a stochastic, mean‐reverting spread. The result is a time‐varying hedge ratio that can be applied to any hedging horizon. We also consider the effect of jumps in the underlying asset. We use simulations and empirical tests of crude oil, jet fuel cross hedges to demonstrate the hedging effectiveness of the model. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:736–756, 2009