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TESTING HEDGE EFFECTIVENESS FOR FAS 133: THE VOLATILITY REDUCTION MEASURE
Author(s) -
Kalotay Andrew,
Abreo Leslie
Publication year - 2001
Publication title -
journal of applied corporate finance
Language(s) - English
Resource type - Journals
eISSN - 1745-6622
pISSN - 1078-1196
DOI - 10.1111/j.1745-6622.2001.tb00429.x
Subject(s) - hedge , volatility (finance) , actuarial science , hedge accounting , cash flow , economics , measure (data warehouse) , fair value , accounting , business , econometrics , computer science , mark to market accounting , financial accounting , accounting information system , data mining , ecology , biology
Although the authors of this article praise the spirit of the new FASB guidelines for hedge accounting, they find flaws in the recommended tests for determining if a hedge qualifies for such treatment. In some cases, the tests recommended by the FASB pass hedges that clearly should fail, and in others they fail hedges that should be accepted. In place of the recommended testing procedures, the authors propose the use of the volatility reduction measure (VRM)—a measure that is fully compliant with the spirit of the FASB's recommendations, while correcting their major shortfalls. While the illustrations in this article are from the realm of fixed income, the VRM approach is applicable to any hedge, whether designated as “fair value” or “cash flow.” Moreover, by expressing volatility in the units of the widely used “Value at Risk” measure, VRM establishes a natural link between accounting and risk management.