Bridge over ocean
1 January 2008 Financial Analysts Journal Volume 64, Issue 1

Combination Hedges Applied to U.S. Markets

  1. Lawrence Morgan

Financial futures hedges typically use one futures market (e.g., a 10-year-note futures to hedge a position in 10-year U.S. Treasury securities). This article reports tests of combination hedges composed of 10-year-note futures and long-bond futures to hedge 10-year Treasuries and compares combination hedges with the standard one-market hedge. The study applies to the U.S. market an approach developed and tested successfully for the German bond market. Combination hedges are generally found to be superior. Of three methods examined for determining hedge ratios—using yields, option-adjusted modified durations, or non-option-adjusted modified durations—combination hedge ratios derived from option-adjusted modified durations performed best.

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