CASE STUDY: IMPERFECT HEDGE

CASE STUDY:

IMPERFECT HEDGE

Ritu Sekhani , Sonali Varma

Universal Business School, Mumbai.

Introduction

In Arbitrage Theory, Hedging[1] Strategy is an approach to eliminate the total risk, also known as Perfect hedge. Perfect Hedge will not be perfect solution to portfolio as they are exposed to market risk that can’t be controlled, therefore, financial firm and analysts opted for minimum loss strategy that is imperfectly hedged[2]. A strategy where they hedge their share or portfolio in such a way that their client would suffer minimum loss instead of losing out on everything. The loss function will represent the performance of the market/ company.

We will be looking at the market performance of COALINDIA[3] of October 2021. A hedge that does not entirely eliminate market risk. Changes in the underlying position are not entirely reflected by changes in the hedge. This may be owing to timing issues or to the use of hedging instruments that are not entirely correlated to the underlying position.