Generalized Autoregressive Conditional Heteroskedasticity Finance Essay - Free Essay Example

Sample details Pages: 5 Words: 1590 Downloads: 6 Date added: 2017/06/26 Category Finance Essay Type Analytical essay Did you like this example? Many companies, both producers and/or users of commodities can be negatively impacted by sudden price changes in their production inputs or outputs. Producers of commodities such as in the mining, oil or farming industries would sure benefit from increasing prices of their respective outputs, but face a risk of very serious losses and even bankruptcy should the opposite happens. On the other hand, within those industries and most others, some commodities are also used as production inputs and therefore would negatively impact companies may prices rise. Don’t waste time! Our writers will create an original "Generalized Autoregressive Conditional Heteroskedasticity Finance Essay" essay for you Create order In all cases, the overall price volatility in commodities is often negatively perceived and, to the extent of a companys level of exposure to commodities in its production process, can be seen as a very serious business risk. (). In order to reduce some of the risk and often with the objective of protecting their profit margins, companies will resort to hedging. The risk management strategy of hedging can be described as a way limit or offset the probability of a loss from the volatility in the price of a commodity, securities and/or currency (Hull, 2012). For the purpose of this thesis, a hedge will be defined as taking a short position in the futures market in order to cover one contract of a long position held in the spot market by the hedger. Other derivatives such as forward contracts or options are also used for hedging purposes, but futures are seen as the most dominant in commodity markets mainly because of their liquidity and transparency advantages (Geman, 2005). The exact amount of the futures contract to be purchased against that one spot position is called the hedge ratio (HR) and the HR chosen to minimize the variance (volatility) of the hedgers portfolio will be referred to as the minimum varia nce hedge ratio (MVHR). Countless research papers have been written about MVHR, its relevance and the different ways of estimating it (see, for example Johnson 1960; Ederington, 1979; Myers 199). With constant advancements in the field of Econometrics, researchers began investigating more and more complex methods to derive the MVRH, for example by incorporating time variation into the estimation of the variance-covariance matrix (see, for example .. ****************). However, no clear consensus has been reached yet on the best ways to construct a MVHR, and many of the empirical studies considering assumptions and estimated variables, concluded to somewhat contradictory results. Furthermore, many of the newer, more complicated models require cumbersome econometric models and, therefore, might not be most suitable for actual use by companies in the commercial world. This thesis aims at capturing the recent advancement made on the MVHR while considering and testing models that could be considered as (to be continued (About 1 more page)talk a bit about the commodities +++ the rest of this thesis willÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦ÃƒÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦ ) Framework The Spot and Futures Markets The spot market can be defined as a market where a commodity is bought or sold for immediate (or with a minimum lag) physical delivery. Not that long ago, those markets where actual physical places where buyers and sellers would meet to exchange, for example, their crops. Its important to note that all commodities are traded on spot markets. In the 18th century, some U.S. farmers started selling their own crops at the time of planting to help finance them and across the ocean, in London, metal began trading in the same fashion, leading the way to the first derivative market: the forward market (Geman, 2005). We can consider this market as an informal one where over-the-counter contracts for future delivery of commodities are exchanged by participants. The standardization of such informal markets by ways of controlling quantities, qualities, dates of deliveries and locations, led to the establishment of the Futures exchanges (Bailey, 2005; Hull, 2012). Some of the better known exchanges are, for example, the Chicago Board of Trade (CBOT) founded in 1848 (agricultural and financial futures), the Chicago Mercantile Exchange (CME) founded in 1874 (livestock and financial), the New York Mercantile Exchange (NYMEX) (precious metal and energy) and the London Metal Exchange (LME) (base metal). On these exchanges, standardized contracts are bought and sold by a variety of participants with different objectives. First we have the hedgers, whose opposite positions to their own spot exposure have for goal to reduce risk and protect their profit margins. Second we have the speculators who, taking advantage of the quasi costless characteristic of futures contracts, will use them to speculate on commodity prices. Third comes the arbitrageurs whose presence is essential to make sure the relationship between spot and future prices as well as prices on different exchanges remains true. In principal, the value of a futures contract should approximat e the spot market price plus the cost of carrying the commodity, such as interest, storage and insurance costs. If such difference came to exist, arbitrageur would take position in the markets making a risk free profit and bringing prices back in line in the process. And finally, futures, often due to their unique correlation to financial markets, are now increasingly used by portfolio managers in order to hedge their general portfolio risk (Bailey, 2005; Geman, 2005). Hedging with Futures Contracts As previously discussed, hedging is primarily done with intent of reducing risk. Four basic categories of futures exists where the underlying can be a physical commodity (such as it is the case in this thesis), a foreign currency, an asset earning interest or and index (Hull, 2012). Also, different hedging strategies exists as some hedgers want to protect only part of their exposure sometimes due to a certain risk profile or some industry standards, and others, highly risk averse participant, will choose to eliminate the price risk as much as possible, often preferring to protect their profit margins deriving from their main business activities. Throughout this thesis such an assumption will be made as the HR will be built with the intent of hedging as much as possible the exposure of a risk-averse hedger. This can be referred to as a pure risk-avoidance hedging strategy (Bailey, 2005). In practice, hedgers will use futures contracts in two ways. Companies knowing they will have to buy a certain asset in the future can choose to lock in the price of that asset and buy a long position in a related futures contract (referred to as a long hedge). Alternatively, some companies such as commodity producers will know the approximate quantity of an asset they will have to sell in the future and will want to lock in today the price of that asset (this is referred to as a short hedge). The later way will be used in this thesis to construct the hedged portfolio used in order to assess the hedge effectiveness. As only the variance reduction is considered, using either ways would give the same results. Basis Risk Although hedging aims at reducing risk, doing it right is often not as simple as just buying or selling the opposite quantity of the exposure. This is mainly due to the introduction of basis risk in the equation. Understanding it is essential to understand the reasons being the HR. Basis is defined as: Best example of Basis risk is the German Company and its oil positionÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦ A Look at the Selected Commodities Optimal Hedge Ratio OHR A Review Static versus dynamic hedging OHR for Commodities OHR The Methods To perform an empirical study of the minimum variance hedging strategy, the HR needs to be estimated with the help of some statistical models. (see (19) page 8) No Hegde NaÃÆ'ƒÂ ¯ve Hedge Constant OLS Rolling window OLS EWMA OLS Simplified GARCH (1,1) Data Analysis As the aim of this thesis is to provide evidence of the best hedge ratio methodology using recent data, only the quantitative approach will be used, providing empirical results onÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦. Statisitcal MethodologyÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦ Introduce the reason for the 3 periods (financial crisis.. volatility effect, etc) Statistical Tests Test for Normality Test for Stationary Time Series Test for Autocorrelation Test for Heteroskedasticity Statistical Tests Results Delimitations and Assumptions The main assumption in this thesis, as it also is in most literature relating to OHRs, is that the hedger has perfect knowledge of the amount of commodities needed or produced at a future date. In reality, this is obviously rarely the case, therefore producers or users of commodities will use estimates to construct their hedging strategy (). Delimitations: This thesis do not differentiate between long and short hedgers, exclude foreign exchange risk and possible correlation, Only cover Futures (not Options and FWDs), Focus only on Commodities, No forcast tool intended Only OLS (normal + rolling window) is used, leaving aside GARCH etc Assumptions: Risk aversion, In this thesis, as it the case for most of the literature written on OHRs, only the variance is used as the measure of risk (see for example: balbalbal), therefore making the generally accepted assumption which gives equal weight to both positive and negative returns. Since Markowitz (1952), the variance became the most widely used measure of risk but this traditional approach has been criticized by some (Cotter 2005, etc) who suggested that OHR estimations could be improved if tail specific metrics such VaR, Semi-Variance and LPM were also evaluated. (is this needed because of risk aversion ) Other assumptions: The hedge period is set and sure at the time od hedging No FX is considered Empirical Findings Optimal Hedge Ratio The Results Discussion () Conclusion There is no question to the importance for companies of having a sound and tested risk management strategy. As one of the most traded derivative instruments for commodities, futures certainly play an important role in the hedging process. Appendix

Exploring The Four Ancient Civilizations- Mesopotamia,...

Before the beginning of history, people from across the land gradually developed numerous cultures, each unique in some ways while the same time having features in common. Mesopotamia, Egypt, Greece and Israel are all important to the history of the world because of religious, social, political and economic development. In the first civilization, both Mesopotamia and Egypt relied on a hunter-gatherer economic system, during that time, every country in the world strived on it. Mesopotamia had rich soil for agriculture, but experiences floods. For the Mesopotamians, these floods would destroy major cities, but for the Egyptians it would keep the soil rich all year long without the damage that the Mesopotamians had experienced.†¦show more content†¦Egyptian women could enter into contracts under their own name; they could initiate civil court cases and could, likewise, be sued; they could serve as witnesses in court cases; they could serve on juries; and they could witness lega l documents. Religion was practiced throughout Ancient Mesopotamia and Egypt. Both the Mesopotamians and Egyptians shared polytheistic beliefs. Each god was responsible for an action, but they did not consider the gods to be equal in Mesopotamian society, in order to please the gods, a sacrifice must be made to please them in order to avoid the god’s wrath. The separation of church and state did not exist in both ancient civilizations, pharaohs of Egyptian society was known to be a god on Earth, the incarnation of Horus, the falcon god. The Mesopotamian rulers were known as a representative to the gods. Although they worship to several different gods, they do have differences between the two. The idea of an afterlife, In Mesopotamia didn’t exist but for the Egyptians the idea of an afterlife was of significant importance to them, rituals were held to ensure that the body and soul would be ready for an eternal life after death. The writing systems of both the Mesop otamians and the Egyptians have many similarities. Pictographic writing, which was developed by the

The similarities and differences between the sciences Essay Example For Students

The similarities and differences between the sciences Essay During the course of this essay, I Will attempt first to criticism science and scientists and show the arrogant assumptions that are made about science. Will then discuss the similarities between arts and sciences in the light of my criticisms, and finally look closely at the many differences between arts and sciences. There are several different criticisms that have been commonly leveled at science and scientists as a whole. Shall begin by attempting to identify these criticisms and identifying the reasoning behind each of them. The first of these criticisms is that science has been given similar status to a elision. It was commonly thought in the early days of science that science would eventually develop a theory for everything, thereby replacing religion through removing the ambiguous and the incomprehensible parts to elite with which religion dealt, In many ways science has replaced religion in the 21st century, as it has become the object of faith and even devotion. A blind faith has been placed in the unquestionable correctness of science and scientific research. It avgas Mile Druthers who first advanced the theory that given enough time, science would replace all traditional religions to be replaced by formal, unquestionable religion based upon science. It is the arrogance of many scientists that leads us to believe that scientific theories are facts, and can be treated as truth replacing religion by explaining the facts behind the creation and existence Of the world. The problem With this belief that science is unquestionable fact and can be treated in a similar way to a religion is twofold. First, scientific theories are advanced through observation and experimentation, these theories can never be proved entirely correct since they are based only on certain observations, as the full facts can never be known, a theory can only e said to be correct in so far as it is correct from the observations made given the facts available. Secondly, science and religion can never be directly linked since they do not overlap in any shape or form, Science deals with the physical, religion with the insubstantial. In their very essence the two are diametrically opposed to one another and cant be compared, In short, science deals with the how, religion, the why. Although science attempts to understand the world around us, how it was created and how we and other creatures came to exist, it can never fully explain the automated human search tort a higher being. There seems to be a desire within humans to believe in something larger and greater than that which is visible and physical, something science can never explain. For this reason, science can never replace religion, as it simply does not explain enough. Its explanations tall tar short of what would be needed to satisfy human curiosity. Religion, in general, does a much better job of explaining what needs to be explained about human nature. However, Scientists in recent years hue attempted to give their work a status of being unquestionably correct. As have already explained, the truth of science r the correctness or Otherwise Of a given theory can never be entirely proved. A theory can only be proved correct in so far as it is correct given a certain set Of facts, and Without having all the facts available, a theory can never be given the status of absolute fact, and consequently, no scientific theory can ever be proved, although it can be proved false through further research. However, this strong criticism of science can be taken even further. Karl Popper put forward the theory that scientific facts of the present day are simply probabilities, and only hold this status until such time as new evidence emerges allowing the hero to be dropped or adapted. Thomas Kuhn took this criticism of scientists even further, he believed that scientists, for the vast majority of the time, went to great lengths to fit their experiments to already existing theories, or when new information was taken into account, and it was simply accommodated by existing theories rather than new theories being created. Kuhn went tether in his criticism; he claimed that when new theories were advanced, it was normally due to a competition between two scientists. Eventually, one theory would emerge victorious, however, this emergence, claimed Kuhn, had little to do with he correctness or otherwise of the theory and more to do with the political connections and status of the scientists involved in the battle. Aberdeen takes his criticism of the methodology of science to the extreme and claims that the scientific experiments are not based on observation of facts, but interpretation of vat was seen. Essay On Jefferson EssaySimilarly, the brain Of a painter may interpret a beautiful sunset through the eyes and hence the painter Will paint an image based upon his perception. The historian, in a similar way to the way in which a scientist analyses his collected data, will analyses the facts that are presented to him in order to come up with a theory. In this way the many similarities between the sciences and arts as intellectual disciplines can be seen clearly, they are all ultimately reliant on perception and interpretation. Therefore, it can be assumed that although scientists attempt to distance homeless from and repute any claims that science as a discipline is subject any form of human error and instead attempt to give the impression that scientists are meticulous, rational, careful, observant and prepared to check and recheck theories until it is certain that they are correct, they are in fact as subject to human creativity and capability to make errors as their artistic counterparts, It is this reliance upon humanity in the discipline of science that makes it so similar to the arts in its ability to make assumptions and mistakes. However, despite all of this criticism, it is difficult to compare sciences and arts erectly as they are evidently a considerably different in their very essence as they essentially deal with entirely different concepts, and all though some Of the analysis and observation skills are common to both sorts of discipline the two are in many ways diametrically opposed to one another. Essentially, science is intent upon understanding that which exists in the world around us, whereas the arts are more concerned With interpretation Of that same world. This fundamental emphasis that science places upon understanding may rely upon hurrah observation and inspiration and therefore involve and element of human interpretation, but ultimately is far more concerned with looking closely at the already existing interrelations between two things and upon close scrutiny, an interpretation can be made that can explain for the most part a complex interrelationship. On the other hand, the arts will not delve below the surface and look at the very fundamentals of life itself and break this down through complex analytical processes, instead the arts are concerned with that which exists in a different way. The arts are far more concerned with an appreciation of that which is perceived, and an interpretation tooth same. For example, instead of breaking down a wheat field into many stalks of wheat composed of a stems, composed of vascular bundles and pith etc, an painter or poet will simply look at the beauty of the field in its entirety and write about or paint a picture of what he sees. In conclusion, the sciences and arts have much in common; they are essentially dependent on the human imagination for inspiration. The creative influence of the human mind exerts a powerful influence over both intellectual disciplines, and scientific theories can be considered just as dependent upon this creative factor as the artistic disciplines. However, it can be said that in many ways science is more concerned by observation Of facts reducing the scope for creativity after the initial idea. The scientific may not be able to suppress entirely his creative, artistic side but this is certainly less apparent in the scientist than in the artist. The scientist must be objective and look at everything as impartially as is humanly possible, rather than letting himself be swayed by What he expects or wants to happen. It is obvious that there is a certain element of bias is all scientific theories, but this is less apparent than with the artistic disciplines, here the artist has total control over how he portrays a given instance or scene and what bias he personally has. Sciences and arts separate essentially in what they deal with as a discipline, Science is essentially concerned with understanding, whereas the arts are more concerned with perception. This is the fundamental difference been the sciences and arts as intellectual disciplines, and although there are many comparisons to be drawn between to two intellectual disciplines due to their common dependence upon the frailties and faults of human nature, they are never the less essentially different in what they concentrate on,