The Effectiveness Of Hedging Models Under The Precondition Of Minimal Variance

Risk aversion and price discovery are two basic functions of the futures market. Of the two functions, the former is more and more widely used in reality, and is fulfilled by hedging. The essence of futures hedging is that it uses the basis risk instead of cash risk. Hedging ratio refers to the ratio of the investor-held futures contract positions size to the amount of cash assets with corresponding possibility of risks.The paper is composed of seven parts. The first chapter is introduction, including research background, research significance, literature review, research framework and research methods. Literature review looks at the development of domestic and foreign studies on hedging, which is the theoretical basis of the paper and can be divided into three stages. First, Keynes (1923,1930) and Hicks (1946) took the lead in putting forward a complete hedging theory. Then, Working (1960) proposed the basis profit hedging theory. Finally, Markowitz’portfolio theory established the basis for modern hedging theory. Portfolio theory mainly contains two categories; the study of minimum risk hedging ratio from the aspect of minimizing the risk of portfolio returns, and research on mean-variance hedging ratio from the perspective of utility maximization by weighing the benefits and income portfolio variance. The second chapter is an overview of the futures market. It first describes the emerging, traits, functions and role of futures, then explains how the steel futures contract came into being and its development, and provides further information about the development of steel futures market in China. The third chapter is about relevant theories of hedging, explaining the concept of hedging and the role of hedgers in the futures market, expounding the principle of hedging against risks, and listing the rules that should be followed for investors’ reference. The fourth chapter talks about how to identify the optimal hedging ratio and evaluate hedging effectiveness. Firstly, the concept of the basis and basis risk are explained. Secondly, the optimal hedging ratio is figured out under the framework of risk minimization. Finally, hedging effectiveness of the model is given a comprehensive analysis by means of risk minimum principle and Sharp largest principle. The fifth chapter discusses hedging models, including traditional full hedging model and modern hedging model based on Markowitz portfolio theory, the latter of which can be further divided into static hedging model and dynamic hedging model according to the status (static or dynamic) of hedging ratio. The sixth chapter compares the optimum hedging ratios of different models and their effectiveness through empirical analysis, concluding that:1. the State Space Model (SSM) performs better than OLS and VAR models, both of which are based on the analysis of the residual, therefore the advantages of kalman filtering algorithm are obvious;2. On the whole, dynamic hedging model outperforms static hedging model. The seventh chapter is summarizes entire text, and puts forward the best hedging strategies that suit to Chinese steel futures market, thus providing references for investors.The deficiency of this paper is that:for one thing, the combination model introduced into substitute contract cannot refuse the hypothesis of λ=0, so the hedging ratio of the combination model is not available. For another, the paper offers the methods that estimate the hedging ratio, but it does not propose a specific hedging operation scheme.