Minimum Variance hedge ratio

[anupamjain008]

David on page number 12 of book 2 you have mentioned a scenario wherein the jet fuel price increases by $1/gallon.

I have got the answer till the computation of number of contracts 16.25 but I can't understand after that. How did you get Futures price gain $1.51 and proceeded further? Please explain.

 

[David Harper CFA FRM]

anupamjain008,

Here is link to the XLS.

I divided the +1$ spot change by r^2: correlation is (r) but coefficient of determination (r^2) gives the change in future price "explained by" change in spot.

Do you mind me asking, how did you get a copy of PDF?

Thanks,
David

 

[mikey10011]

It is still not clear to me how the change in future price ["Futures Price Gain" = E29] can be computed the change in spot price of jet fuel [E28 = $1] divided by r^2.

I thought r^2 was a measure of the "goodness of fit" (r =1 means a perfect linear fit; r = 0 means uncorrelated or totally random scatter plot; r = -1 means perfect negative linear correlation). Q: What do you mean by "explained by?"

Using linear regression don't we need to calculate the slope ("beta") between the deltaF and deltaS [=SLOPE(D516, E5:E16)]?

Also this is my first time on this forum. What is does "Fast Reply" and "Post Reply" mean?

 

[mikey10011]

Ooops, typos. It is still not clear to me how the change in futures price ["Futures Price Gain” = E29] can be computed by the change in spot price of jet fuel [E28 = $1] divided by r^2.

I thought r^2 was a measure of the “goodness of fit” (r =1 means a perfect linear fit; r = 0 means uncorrelated or a totally random scatter plot; r = -1 means perfect negative linear correlation). Q: What do you mean by “explained by?”

Using linear regression don’t we need to calculate the slope ("beta") between the deltaF and deltaS [=SLOPE(D516, E5:E16)]?

Also this is my first time on this forum. What is does “Fast Reply” and “Post Reply” mean?

 

[David Harper CFA FRM]

Geez...i thought it was a nice trick but now i think it was a total brain fart. I agree with you completely. I don't really know what I was thinking!? Thank you for pointing this out...I will correct the XLS...

Fast Reply: frankly, i am not sure, it came with the forum module.

Thanks for your first post, value add! David

@anupamjain008: You were right to question, as Mickey has pointed out. Apologies.

 

[David Harper CFA FRM]

anupamjain008 & Mikey,

Please note I (finally) correct the bottom of the minimum variance hedge XLS to "test" for the hedge using the beta (slope) as you correctly point out should be used.

XLS @ http://www.bionicturtle.com/premium/editgrid/2008_frm_hull_derivatives_minimum_variance_hedge/

David