Optimal Dynamic Hedging Using Futures Under a Borrowing Constraint

Topics:
Equity,
Strategic Planning and Analysis
Tags:
Asset Management,
Bank For International Settlements,
Business Operations,
Management,
Operational Planning,
Strategy
Source:
Bank for International Settlements

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Overview: Both financial and non-financial firms routinely implement hedging policies to mitigate their exposure to changes in asset prices. This paper derives the dynamic hedging strategy of a firm that uses futures contracts to hedge a spot market exposure. The risk emanating from the margin requirement on futures contracts is incorporated into the hedging decision by restricting the borrowing capacity of the firm. It is shown that this leads to a substantial reduction in the firm’s optimal hedge, especially if the hedging horizon is long. The results provide theoretical support for the low level of hedging observed empirically.

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Format: PDF | Size: 278KB | Date: Jan 2002 | Pages: 33

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