Current research suggests that the large downside risk in hedge fund returns disqualifies the variance as an appropriate risk measure. For example, one can easily construct portfolios with nonlinear pay-offs that have both a high Sharpe ratio and a high downside risk. This paper examines the consequences of shortfall-based risk measures in the context of portfolio optimization. In contrast to p...

Electricity industries worldwide have been restructured in order to introduce competition.As a result, decisionmakers are exposed to volatile electricity prices, which are positively correlated with those of natural gas in markets with price-setting gas-fired power plants. Consequently, gas-fired plants are said to enjoy a “natural hedge.” We explore the properties of such a built-in hedge for ...

We develop a model of hedge fund returns, which reflect the contractual relationships between a hedge fund, its investors and its prime brokers. These relationships are modelled as short option positions held by the hedge fund, wherein the “funding option” reflects the short option position with prime brokers and the “redemption option” reflects the short option position with the investors. Giv...

In this study, a novel procedure combining computational intelligence and statistical methodologies is proposed to improve the accuracy of minimum-variance optimal hedge ratio (OHR) estimation over various hedging horizons. The time series of financial asset returns are clustered hierarchically using a growing hierarchical self-organizing map (GHSOM) based on the dynamic behaviors of market flu...

Financial and insurance theories explain that large widely-held corporations manage corporate risks if doing so is cost-effective to reduce frictional costs such as taxes, agency costs and financial distress costs. A large number of previous empirical studies, most in the U.S., have tested the hypotheses underlying corporate risk management with financial derivative instruments. In order to qua...

This paper utilises a new approach for determining minimum variance hedge ratio in stock index futures markets. More specifically, the performance of time-varying hedge ratios generated from Markov Regime Switching (MRS) models is investigated. The rational behind the use of these models stems from the fact that the dynamic relationship between spot and futures returns may be characterised by r...

This paper investigates and compares the performances of the optimal portfolio selected by using the Orthogonal GARCH (OGARCH) Model, Markov Switching Model and the Exponentially Weighted Moving Average (EWMA) Model in a fund of hedge funds. These models are used to calibrate the returns of four HFRX indices from which the optimal portfolio is constructed using the Mean-Variance method. The per...

Managing price risk with futures contracts creates liquidity risk through marking to market. Liquidity risk matters in an imperfect capital market where interim losses on a futures position have to be financed at a borrowing rate that is higher than the risk-free rate. However, the impact of liquidity risk can be mitigated using options on futures. This paper analyzes the optimal risk managemen...