What is Optimal Hedge Ratio ?
The optimal hedge ratio refers to the ideal proportion of a hedging asset that an investor should hold relative to the position being hedged. It is determined through statistical analysis, taking into account factors such as the volatility of the asset being hedged, the correlation between the hedging asset and the asset being hedged, and the investor's risk tolerance. By using the optimal hedge ratio, investors aim to minimize the overall risk exposure of their portfolio while still benefiting from potential gains. For example, in commodities trading, a producer might use futures contracts to hedge against price fluctuations. The optimal hedge ratio in this context would be the quantity of futures contracts that provides the most effective hedge against adverse price movements in the underlying commodity.Finding the optimal hedge ratio involves complex calculations and modeling techniques, often utilizing statistical methods such as regression analysis.
How to Calculate Optimal Hedge Ratio?
Optimal Hedge Ratio calculator 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 calculate 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 calculate Optimal Hedge Ratio using this online calculator? To use this online calculator 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. Here is how the Optimal Hedge Ratio calculation can be explained with given input values -> 0.166667 = (0.05/0.09)*0.3.