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Optimal Hedge Ratio Formula

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Optimal Hedge Ratio is the proportion of a position in a hedging asset relative to the position being hedged, aiming to minimize risk exposure while maximizing effectiveness in hedging. Check FAQs

Δ optimal = (\frac{σ s}{σ f}) \cdot ρ s/f

Δ_optimal - Optimal Hedge Ratio?σ_s - Standard Deviation of Changes in Spot Price?σ_f - Standard Deviation of Changes in Futures Price?ρ_s/f - Correlation of Changes in Spot and Futures Prices?

Optimal Hedge Ratio Example

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Here is how the Optimal Hedge Ratio equation looks like with Values.

Here is how the Optimal Hedge Ratio equation looks like with Units.

Here is how the Optimal Hedge Ratio equation looks like.

0.1667 = (\frac{0.05}{0.09}) \cdot 0.3

0.1667 = (\frac{0.05}{0.09}) \cdot 0.3

0.1667 = (\frac{0.05}{0.09}) \cdot 0.3

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Optimal Hedge Ratio Solution

Follow our step by step solution on how to calculate Optimal Hedge Ratio?

FIRST Step Consider the formula

Δ optimal = (\frac{σ s}{σ f}) \cdot ρ s/f

Next Step Substitute values of Variables

∴

Δ optimal = (\frac{0.05}{0.09}) \cdot 0.3

Next Step Prepare to Evaluate

∴

Δ optimal = (\frac{0.05}{0.09}) \cdot 0.3

Next Step Evaluate

∴

Δ optimal = 0.166666666666667

LAST Step Rounding Answer

∴

Δ optimal = 0.1667

Optimal Hedge Ratio Formula Elements

Variables

Optimal Hedge Ratio

Optimal Hedge Ratio is the proportion of a position in a hedging asset relative to the position being hedged, aiming to minimize risk exposure while maximizing effectiveness in hedging.

Symbol: Δ_optimal

Measurement: NAUnit: Unitless

Note: Value should be greater than 0.

Formulas to find Optimal Hedge Ratio

Standard Deviation of Changes in Spot Price

Standard Deviation of Changes in Spot Price measures the volatility or variability of price movements over time for a financial asset or security.

Symbol: σ_s

Measurement: NAUnit: Unitless

Note: Value should be greater than 0.

Formulas to find Standard Deviation of Changes in Spot Price

Standard Deviation of Changes in Futures Price

Standard Deviation of Changes in Futures Price measures the variability or dispersion of price movements over time for a futures contract, reflecting the degree of market volatility.

Symbol: σ_f

Measurement: NAUnit: Unitless

Note: Value should be greater than 0.

Formulas to find Standard Deviation of Changes in Futures Price

Correlation of Changes in Spot and Futures Prices

Correlation of Changes in Spot and Futures Prices is the linear relationship between the movements of spot prices and corresponding futures prices.

Symbol: ρ_s/f

Measurement: NAUnit: Unitless

Note: Value should be greater than 0.

Formulas to find Correlation of Changes in Spot and Futures Prices

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How to Evaluate Optimal Hedge Ratio?

Optimal Hedge Ratio evaluator uses Optimal Hedge Ratio = (Standard Deviation of Changes in Spot Price/Standard Deviation of Changes in Futures Price)*Correlation of Changes in Spot and Futures Prices to evaluate the Optimal Hedge Ratio, The Optimal Hedge Ratio is the proportion of a position in a hedging asset relative to the position being hedged, aiming to minimize risk exposure while maximizing effectiveness in hedging. Optimal Hedge Ratio is denoted by Δ_optimal symbol.

How to evaluate Optimal Hedge Ratio using this online evaluator? To use this online evaluator for Optimal Hedge Ratio, enter Standard Deviation of Changes in Spot Price (σ_s), Standard Deviation of Changes in Futures Price (σ_f) & Correlation of Changes in Spot and Futures Prices (ρ_s/f) and hit the calculate button.

FAQs on Optimal Hedge Ratio

What is the formula to find Optimal Hedge Ratio?

The formula of Optimal Hedge Ratio is expressed as Optimal Hedge Ratio = (Standard Deviation of Changes in Spot Price/Standard Deviation of Changes in Futures Price)*Correlation of Changes in Spot and Futures Prices. Here is an example- 0.166667 = (0.05/0.09)*0.3.

How to calculate Optimal Hedge Ratio?

With Standard Deviation of Changes in Spot Price (σ_s), Standard Deviation of Changes in Futures Price (σ_f) & Correlation of Changes in Spot and Futures Prices (ρ_s/f) we can find Optimal Hedge Ratio using the formula - Optimal Hedge Ratio = (Standard Deviation of Changes in Spot Price/Standard Deviation of Changes in Futures Price)*Correlation of Changes in Spot and Futures Prices.

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Optimal Hedge Ratio Formula

Optimal Hedge Ratio Example

Optimal Hedge Ratio Solution

Optimal Hedge Ratio Formula Elements

Other formulas in International Finance category

How to Evaluate Optimal Hedge Ratio?

FAQs on Optimal Hedge Ratio

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