Best hedge – 6 min briefcast

by David Harper, CFA, FRM, CIPM

FRM |

A brief review of the best hedge (Jorion Chapter 7). The best hedge is based on portfolio volatility in the mean-variance framework. Specifically,

• Given a current portfolio with value (W), and
• Given an asset (A) with correlation (rho) to the portfolio,
• What is the trade that produces the minimum volatility for the new portfolio (W+a)?

Note the translation from one version of the best hedge (below left) to the version that includes beta; i.e., beta is covariance (portfolio, instrument)/variance(portfolio):

Screencast:

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