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On
the Pricing and Hedging of Options on Commodity Forward and
Futures Contracts: A Note
-- Valeri
I Zakamouline
In
recent years some organized markets have appeared for forward contracts and options
on these contracts. This paper briefly reviews the organization of trade in a
centralized forward market. Assuming a friction-free market with constant interest
rate, a consistent and continuous time framework is built for the valuation and
hedging of options on a forward or a futures contract. This framework takes into
account the peculiarities of a forward/futures contract. In this framework the
paper analyzes the pricing and hedging of options on a forward contract and reconsiders
the Black-76 model for the pricing and hedging of options on a futures contract. ©
2007 IUP . All Rights Reserved.
Effectiveness
of Time-Varying Hedge Ratio with Constant Conditional Correlation:
An Empirical Evidence from the US Treasury Market
--
Sheraz Ahmed
This
study demonstrates how hedging methodologies can be evaluated in a modern risk
management context and provides hedging effectiveness of dynamic hedge ratios.
The results clearly indicate the superior performance of the time-varying hedge
ratio, compared to the traditional duration-based constant ratio. Time-varying
hedge ratio, which is estimated using CCC-GARCH model of Bollerslev (1990), shows
a clear advantage in minimizing the variance of portfolio returns over a period
of 10 years. The time-varying hedge ratio takes into account the conditional heteroskedasticity
of the spot market yield curve. It provides an efficient measure for bond investors
to maximize the value of their investments by changing positions in corresponding
future markets of the US Treasury bonds according to the changes in actual yields
of cash market. The results are robust in the sense that constant conditional
correlation model takes account of the conditional heteroskedasticity present
in the data of spot market. ©
2007 IUP . All Rights Reserved.
Improving
Risk-Adjusted Returns of Fixed-Portfolios with VIX Derivatives
--
Gang Dong This
paper proposes an optimal asset allocation scheme for well-diversified fixed-portfolios
to improve risk-adjusted returns. The annual returns and realized volatilities
of a well-diversified portfolio, VIX (CBOE Volatility Index) and VIX futures price
have been calculated and analyzed over a period of 13 years. Two portfolios are
created to include the hedging effects of a hypothetical derivative linked to
the S&P 500 volatility index and VIX futures contract. The risk-adjusted returns
of the real portfolio and hypothetical portfolio are compared and the optimal
asset allocation ratios are derived from an iteration process. The in-sample statistic
result shows that by allocating an approximate 7% portfolio weight on a hypothetical
derivative linking to VIX index, the portfolio approaches its optimal risk-adjusted
return ratio. In an out-of-sample forward testing, the volatility of the real
portfolio is reduced on an average of 4.5%, while return is reduced only by about
1.6%. The empirical evidence of enhancing risk-adjusted returns on fixed-portfolios
with VIX hedging is obvious when allocating 6.5% asset in VIX futures contracts
and another 6.5% weight in interest bearing risk-free bonds. ©
2007 IUP . All Rights Reserved.
Expiration
Day Effect of Stock Derivatives on the Volatility, Return
and Trading Volume of Underlying Stocks
--
Kiran Jindal and B S Bodla
Derivatives
trading is an integral part of the maturing process of capital market of every
nation. Derivatives were introduced as a risk management tool in the financial
market. Since, its very inception in 1865 on Chicago Board of Trade, policy makers
and regulators were concerned about its impact on the underlying stock market.
Most of them were of the belief that futures trading attracts speculators and
arbitrageurs who destabilize the spot prices, especially on the expiration day
of these derivatives contracts. In this paper, an attempt has been made to analyze
the effect of expiration of stock derivatives on the volatility, return and trading
volume of underlying individual stocks listed on National Stock Exchange (NSE).
The results from the sample period show the presence of an abnormally high volume
on expiration day, thereby suggesting that arbitrage and manipulating activities
take place in the market and that positions are unwound at the expiration. Hence,
there is a greater volatility in the market on the expiration day. However, the
unwinding of arbitrage positions failed to cause any significant price distortion
at expiration, as there is no significant change in the return on stocks on the
expiration day. ©
2007 IUP . All Rights Reserved.
Informational
Efficiency of the Malaysian Crude Palm Oil Futures Contracts
-- Taufiq Hassan, Shamsher Mohamed and Fatimah Mohamed Arshad The
study examines the informational efficiency of the Malaysian crude palm oil futures
contracts by separating the futures prices according to their maturity life cycle.
If futures price formation follows the rational expectation, then information
will flow from futures to spot and not the other way round. The results are generally
consistent with the expectations. All distant month error terms in spot equation
are statistically significant for the three sub-samples (1987-89, 1990-92 and
1996-98). The findings are also consistent with the notion that all expectations
will converge to the terminal month price and that the spot market plays a dominant
role along with futures market in adjusting to each other. These findings are
consistent with a matured commodity futures market microstructure. ©
2007 IUP . All Rights Reserved. | 
