Work detail

Hedging with interest rate derivatives: Estimation of hedge ratio & hedging effectiveness

Author: Mgr. Marika Ruberry
Year: 2020 - winter
Leaders: PhDr. Petr Gapko Ph.D.
Work type: Finance, Financial Markets and Banking
Language: English
Pages: 110
Awards and prizes:
Abstract: The thesis investigates the effectiveness of several hedging strategies and inspects whether
advanced econometric models contribute to lower portfolio risk and offer advantages over
simple constant hedges. Focused on the German bond market, Euro-Bund and Euro-Bobl
futures traded at Eurex are employed to determine which hedging strategy performs best in
the fixed-income framework. The hedge ratio is estimated with the OLS, VAR, VECM, and
GARCH models, as well as with the duration-based approach. The hedging effectiveness
is subsequently measured in terms of percentage variance reduction of a portfolio’s returns
relative to an unhedged bond, while also considering risk-return trade-off. The analysis
showed that the hedging strategies are, in almost all cases, effective in risk minimization
though the degree of variance reduction does differ. The duration method decreases the
variance by as much as 99% while mostly resulting in low or negative returns. Relative to
other constant strategies, the time-varying hedge ratio, estimated by the GARCH, limits
the variance least, nonetheless, mostly it provided a variance reduction of at least 65%
while also delivering one of the highest returns. Whereas the dynamic strategy did not
outperform constant hedges in terms of risk protection, the choice of hedge ratio eventually
depends on an investor’s risk appetite and potential costs of portfolio rebalancing when
employing a dynamic approach.
July 2020




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