The Minimum Variance Hedge Ratio and Beta Hedging using Futures
from Patrick Boyle Hosted by Patrick Boyle
These classes are all based on the book Trading and Pricing Financial Derivatives, available on Amazon at this link. https://amzn.to/2WIoAL0 Check out our website http://www.onfinance.org/Follow Patrick on twitter here: https://twitter.com/PatrickEBoyleOne problem with using financial futures contracts to hedge a portfolio of assets, is that a perfect futures contract may not exist. Thus a perfect hedge cannot be achieved.An example would be, if an airline company executive wished to hedge the company's exposure to jet fuel prices, and found that there was no jet fuel futures market or if they found that a futures market exists but it is so illiquid that it is functionally useless.The CFO then needs to find a way to use a different contract that is highly correlated with the underlying asset and has a similar variance. This is done using the minimum variance hedge ratio.The minimum variance hedge ratio (or optimal hedge ratio) is the ratio of futures position relative to the spot position that minimizes the variance of the position. In this video we will learn how to do this calculation.We also learn how to use beta in hedging a portfolio of stocks using S&P500 index futures.minimum variance portfolio.beta hedging equity portfolio
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