Question

Suppose that the standard deviation of monthly changes in the spot price of commodity A is $20. The standard deviation of monthly changes in a futures price for a contract on commodity B (which is similar to commodity A) is $24. The correlation between the futures price change and the commodity spot price change is 0.95. What hedge ratio should be used when using the futures contract on commodity B to hedge an exposure to a decrease in the price of commodity A?

Answer 1

Answer:

The answer is 0.79166

Explanation:

The hedge ratio is given by correlation * spot A stddev / future A stddev  

The optimal hedge ratio is 0.95×($20/$24) = 0.79166