Cross Hedging of Various Asset Classes - Review and Analysis

Abstract

Cross hedging has emerged as an effective tool to reduce price risk for different classes where a direct hedge through futures market is not available. Many studies have been conducted to explore the correlation between different asset classes like currency, commodity, stocks, and stock index, insurance and inflation derivatives and analyze the maximum risk reduction possible with different portfolios and combinations. This review paper has attempted to analyze the several studies conducted on cross hedging ranging from simple currency and commodity derivatives to complex inflation and insurance derivatives. The methodology used for these studies and also the effectiveness of these techniques have been studied and analyzed. Cross hedges have been found to be more effective than direct hedges effetiveness of hedging is judged by finding optimal hedge ratio with different models like minimum valance model, Daily Dynamic Conditona l Correlation (DCC) - GARCH, traditional cross hedging, multiplicative cross hedging & Bayesian Procedures.