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Basis Risk (basis + risk)

Distribution by Scientific Domains

Business, Economics, Finance and Accounting	100%

Selected Abstracts

Handling Weather Related Risks Through the Financial Markets: Considerations of Credit Risk, Basis Risk, and Hedging

JOURNAL OF RISK AND INSURANCE, Issue 2 2007
Linda L. Golden
The profits of many businesses are strongly affected by weather related events, and insurance against weather related risks (acts of God) has been a traditional domain for transfer of (certain) of these risks. Recent innovations in the capital market have now provided financial instruments to transfer and hedge some of these risks. Unlike insurance solutions, however, using these financial derivative instruments creates a situation in which the return to the purchaser of the instrument is no longer perfectly correlated with the loss experienced. Such a mismatch creates new risks which must be examined and evaluated as part of ascertaining cost effective risk management plans. Two newly engendered risks, basis risk (the risk created by the fact that the return from the financial derivative is a function of weather at a prespecified geographical location which may not be identical to the location of the firm) and credit risk (the risk that the counterparty to the derivative contract may not perform), are analyzed in this article. Using custom tailored derivatives from the over the counter market can decrease basis risk, but increases credit risk. Using standardized exchange traded derivatives decreases credit risk but increases basis risk. Here also the effectiveness of using hedging methods involving forwards and futures having linear payoffs (linear hedging) and methods using derivatives having nonlinear payoffs such as those involving options (nonlinear hedging) for the purpose of hedging basis risk are examined jointly with credit risk. [source]

Hedging in Futures and Options Markets with Basis Risk

THE JOURNAL OF FUTURES MARKETS, Issue 1 2002
Olivier Mahul
This paper analyzes the hedging decisions for firms facing price and basis risk. Two conditions assumed in most models on optimal hedging are relaxed. Hence, (i) the spot price is not necessarily linear in both the settlement price and the basis risk and (ii) futures contracts and options on futures at different strike prices are available. The design of the first-best hedging instrument is first derived and then it is used to examine the optimal hedging strategy in futures and options markets. The role of options as useful hedging tools is highlighted from the shape of the first-best solution. © 2002 John Wiley & Sons, Inc. Jrl Fut Mark 22:59,72, 2002 [source]

Financial Intermediaries and Interest Rate Risk: II

FINANCIAL MARKETS, INSTITUTIONS & INSTRUMENTS, Issue 5 2006
Sotiris K. Staikouras
The current work extends and updates the previous survey (Staikouras, 2003) by looking at other aspects of the financial institutions' yield sensitivity. The study starts with an extensive discussion of the origins of asset-liability management and the subsequent work to identify effective ways of measuring and managing interest rate risk. The discussion implicates both regulatory and market-based approaches along with any issues surrounding their applicability. The literature is enriched by recognizing that structural and regulatory shifts affect financial institutions in different ways depending on the size and nature of their activities. It is also noted that such shifts could change the bank's riskiness, and force banks to adjust their balance sheet size by altering their maturity intermediation function. Besides yield changes, market cycles are also held responsible for asymmetric effects on corporate values. Furthermore, nonstandard investigations are considered, where embedded options and basis risk are significant above and beyond the intermediary's rate sensitivity, while shocks to the slope of the yield curve is identified as a new variable. When the discount privilege is modeled as an option, it is shown that its value is incorporated in the equities of qualifying banks. Finally, volatility clustering is further established while constant relative risk aversion is not present in the U.S. market. Although some empirical findings may be quite mixed, there is a general consensus that all forms of systematic risk, risk premia, and the risk-return trade-off do exhibit some form of variability, not only over time but also across corporate sizes and segments. [source]

Handling Weather Related Risks Through the Financial Markets: Considerations of Credit Risk, Basis Risk, and Hedging

Does an index futures split enhance trading activity and hedging effectiveness of the futures contract?

THE JOURNAL OF FUTURES MARKETS, Issue 12 2006
Lars Nordén
Recently, several stock index futures exchanges have experimented with an altered contract design to make the contract more attractive and to increase investor accessibility. In 1998, the Swedish futures exchange (OM) split the OMX-index futures contract with a factor of 4:1, without altering any other aspect of the futures contract design. This isolated contract redesign enables a ceteris paribus analysis of the effects of a futures split. The purpose is to investigate whether the futures split affects the futures market trading activity, as well as hedging effectiveness and basis risk of the futures contract. A bivariate GARCH framework is used to jointly model stock index returns and changes in the futures basis, and to obtain measures of hedging efficiency and basis risk. Significantly increased hedging efficiency and lower relative basis risk is found following the split. In addition, evidence of an increased trading volume is found after the split, whereas the futures bid-ask spread appears to be unaffected by the split. The results are consistent with the idea that the futures split has enhanced trading activity and hedging effectiveness of the futures contract, without raising the costs of transacting at the futures market. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:1169,1194, 2006 [source]

Conditional OLS minimum variance hedge ratios

THE JOURNAL OF FUTURES MARKETS, Issue 10 2004
Joëlle Miffre
The paper presents a new methodology to estimate time dependent minimum variance hedge ratios. The so-called conditional OLS hedge ratio modifies the static OLS approach to incorporate conditioning information. The ability of the conditional OLS hedge ratio to minimize the risk of a hedged portfolio is compared to conventional static and dynamic approaches, such as the naïve hedge, the roll-over OLS hedge, and the bivariate GARCH(1,1) model. The paper concludes that, both in-sample and out-of-sample, the conditional OLS hedge ratio reduces the basis risk of an equity portfolio better than the alternatives conventionally used in risk management. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:945,964, 2004 [source]

Hedging in Futures and Options Markets with Basis Risk

Hedging dairy production losses using weather-based index insurance

AGRICULTURAL ECONOMICS, Issue 2 2007
Xiaohui Deng
Dairy production risk; Index insurance; Temperature,humidity index Abstract This article proposes a temperature,humidity index insurance product and examines whether this product can effectively protect against the risk of reduced milk production caused by heat stress. Results suggest that even when premiums are at higher than actuarially fair levels and the insurance purchaser is faced with both spatial and temporal basis risks, a temperature,humidity index insurance product would provide risk management benefits to a representative south-central Georgia dairy producer. [source]