Commodity Futures Hedging Effectiveness Of The Model

Ever since its birth, future contract has been an effective means for traders and manufacturers to hedge against the fluctuant market price. In recent decades, The Portfolio theory by Markowitz has shaped the guideline of future trading: to minimize the risk (standard error) of the portfolio by adjusting the hedging ratio. However, the rapidly expanding business and speedily increasing speculation has made the future contract not only a risk mitigator but a gambling dice to take advantage of arbitrage. So, the traditional future theory gradually lost ground in such volatile circumstances.This paper started with introducing the modern future theory, proceeded to develop both the modeling approaches and the hedging effectivity criteria in hope of better profiling and measuring the portfolio's risk exposure. We introduced State Space Model and Kalman Filter algorithm and more importantly we developed the VaR-minimizing criterion as an innovative approach to discriminate models. As the result showed, the State Space Model was the best VaR-reducer to PTA portfolio.This paper didn't intend to deny the traditional hedging effectivity criteria, but hoped to implant modern risk management ideology to the future trading, so that we can discern and fathom the risk exposure of the portfolios from an in-depth viewpoint.Take notice that PTA is just this paper's data source, but not the confinement. Actually the conclusion can be applicable to any other kind of future contract, which is definitely very worthy, though different results may be found. This is why this paper is a quite practical guideline for the future trading.