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Testing Hedge Effectiveness For Fas 133: The Volatility Reduction Measure

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  • Andrew Kalotay
  • Leslie Abreo

Abstract

Although the authors of this article praise the spirit of the new FASB guidelines for hedge accounting, they find flaws in the recommended tests for determining if a hedge qualifies for such treatment. In some cases, the tests recommended by the FASB pass hedges that clearly should fail, and in others they fail hedges that should be accepted. In place of the recommended testing procedures, the authors propose the use of the volatility reduction measure (VRM)—a measure that is fully compliant with the spirit of the FASB's recommendations, while correcting their major shortfalls. While the illustrations in this article are from the realm of fixed income, the VRM approach is applicable to any hedge, whether designated as “fair value” or “cash flow.” Moreover, by expressing volatility in the units of the widely used “Value at Risk” measure, VRM establishes a natural link between accounting and risk management.

Suggested Citation

  • Andrew Kalotay & Leslie Abreo, 2001. "Testing Hedge Effectiveness For Fas 133: The Volatility Reduction Measure," Journal of Applied Corporate Finance, Morgan Stanley, vol. 13(4), pages 93-99, January.
    • Handle: RePEc:bla:jacrfn:v:13:y:2001:i:4:p:93-99
    DOI: 10.1111/j.1745-6622.2001.tb00429.x
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    Cited by:

    1. Mun, Kyung-Chun, 2016. "Hedging bank market risk with futures and forwards," The Quarterly Review of Economics and Finance, Elsevier, vol. 61(C), pages 112-125.
    2. Jatinder Pal Singh, 2018. "On hedge effectiveness assessment under IFRS 9," The Audit Financiar journal, Chamber of Financial Auditors of Romania, vol. 16(149), pages 157-157, February.
    3. J. P. Singh, 2019. "Hedge Accounting: An Auditor’s Perspective," The Audit Financiar journal, Chamber of Financial Auditors of Romania, vol. 17(153), pages 106-106.

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