Estimating Futures Hedge Ratios for Global Equity Portfolios

Summary

The document considers how a bank could hedge a seeded portfolio of global equities when its goal is to build a performance record without taking much market risk. It asks whether to hedge each market’s equity exposure with futures or adjust the hedge for beta. The answer recommends estimating the hedge ratio from the correlation between the position and futures, multiplied by the ratio of their standard deviations. This is the minimum-variance hedge ratio for a single position and hedge instrument, under the assumptions behind that calculation.

The reply says that when correlation and relative volatility are both near one, the hedge notional will be close to the equity position’s dollar value. It offers no data, worked example, or portfolio-level procedure. For a global portfolio, the approach would need to account for each market, currency effects, contract specifications, basis risk, and interactions among holdings; the brief answer does not address those details or guarantee that P&L variation will be eliminated.

Key ideas

• A minimum-variance hedge ratio depends on correlation and the relative volatility of the position and futures.
• When these inputs are near one, the hedge notional may be close to the equity notional.
• A global portfolio may require separate hedges and additional treatment of currency, basis, and portfolio effects.

Tags

# Hedge ratio: hedging a portfolio of global equities with futures


# Hedge ratio: hedging a portfolio of global equities with futures












A bank decides to use $100 million of its capital to launch an investment strategy (seed money). The portfolio which is launched is made of global equities (say ~ 500 equities of different markets).

The bank does not want to be exposed to PnL variations in the portfolio, the intent is only to build a track record for the portfolio. How would you hedge this portfolio?

Do you have to take Beta into account when calculating the hedge ratio?

Or do you simply short futures for the same amount of the long equity positions in each market and roll the futures?

## Answer by ogukku (score -1)

https://quant.stackexchange.com/a/46971

I prefer: corr * (SDstk/SDfut) because it work well in real life. If corr and SDs are all close to one, then you have an optimal instrument with which to hedge such that the notional values of hedge should end up close to equity dollar value.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.