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Cross‐Hedging: Basis Risk and Choice of the Optimal Hedging Vehicle
Author(s) -
Castelino Mark G.,
Francis Jack C.,
Wolf Avner
Publication year - 1991
Publication title -
financial review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.621
H-Index - 47
eISSN - 1540-6288
pISSN - 0732-8516
DOI - 10.1111/j.1540-6288.1991.tb00376.x
Subject(s) - hedge , basis risk , eurodollar , futures contract , treasury , market neutral , economics , actuarial science , selection (genetic algorithm) , econometrics , financial economics , business , portfolio , computer science , ecology , archaeology , capital asset pricing model , artificial intelligence , biology , history
The basis between a futures contract and its underlying instrument is an important measure of the cost of using the futures contract to hedge. In a cross‐hedge, the relative size of the basis of alternative hedging vehicles often plays a decisive role in the selection of the optimal hedging vehicle. After adjusting hedge ratios for basis risk, a genuine risk‐cost trade‐off is seen in hedging 90‐day certificates of deposit with either the Treasury bill contract or the Eurodollar contract. The Eurodollar contract was not uniformly superior as generally believed.