Evaluation On The Risk Of Hedging By Lower Partial Moment

In any economy society, the risk of price fluctuation exists certainly. It differs from generic business risk which can be transferred through insurance agent. If this risk of price fluctuation cannot be transferred from spot market, it will affect normal management of spot market inevitably. Therefore people are in search of methods to transfer the risk of price fluctuation at all times. Along with the formation of derivative tools in the financial derivation market, a kind of method is discovered to transfer the risk of price fluctuation which is hedging.Firstly this paper reviews and summaries the various methods and thoughts of the existing theory in estimate for financial market risk. Secondly a systematic analysis is done for the advantages and shortcomings of involved diversified theory in this field. Then basing on the achievements up to date made in domestic and abroad in related field, a novel risk management quantifying the risk of domestic hedging is proposed, which is correspond to the situation of our country and is available currently and in near future.Hedging with futures contracts is one of the most widely used techniques for managing risk. A futures contract is essentially a promise to buy or sell a specific amount of an asset at a certain time in the future for a certain price. (ledgers who face risk of price fluctuation in spot market manage to offset their exposure by taking an opposite position in the futures market, so that the losses in one market is offset by gains from the other. Traditional hedging analysis adopts variance as the risk measure. Consequently, there are many literatures on futures market searching the minimum variance hedge ratio. It's evident that variance is a two-sided risk measure. However, the common business practice suggests a notion of one-sided risk (downside-risk).The Lower Partial Moment theory of risk measure has unsurpassable advantages than variance theory. Firstly, it regards losing only as factor of measure so that it can reflect the actual mentality for risk of investors and it accords principles in science; Secondly, in view of Utility Function, it only requires investors of risk averse. In other words, it requires that Utility Function is not quadratic as needed in variance but concave. Thus the Lower Partial Moment is regarded as a better method in estimatingfinancial market risk.The key problem in this paper is to settle difficulties in the Lower Partial Moment's computation which lie mainly in density function estimation and bandwidth choice. Here nonparametric kernel estimation is applied to estimate density function, where bandwidth choice uses cross-validation. In this way the optimal hedge ratio can be obtained in Lower Partial Moment. Then people can evade financial market risk better by using hedging strategy with optimal hedge ratio.