Financial Futures Hedging Via Goal Programming

This paper presents multiperiod, multiple objective goal programming as an alternative to the more conventional hedge ratio approaches to financial futures hedging. The described model offers the potential benefits of: (i) simultaneous achievement of multiple hedge-related objectives (i.e., minimization of transactions and margin opportunity costs; regulation of cash flow, and maximization of profits accruing from both the cash and futures positions); and (ii) periodic modification and updating of the futures position, as suggested by actual, observed prices and interest rates, throughout the hedging period. To assess its overall effectiveness, the model was applied to develop appropriate hedging strategies for three separate time periods, each representing a unique interest rate trend (i.e., upward movement, downward movement, and no change). Since real-world implementation of the model requires the use of forecast data, independent forecasts of both cash and futures prices were generated via (1) moving average, (2) exponential smoothing, and (3) random walk techniques. In progressing through each of the 13-week time periods, all forecasts were updated with the previous weeks' actual price data. Revised forecasts and actual price data were then incorporated into the model constraints on a weekly schedule. This approach, in essence, provided weekly futures activity recommendations based on the most recent price and interest rate developments observed at any point during the hedging period. The realized gains or losses were then compared to the previously-derived "perfect foresight" model results and to the traditional hedge ratio results. This allowed for evaluation of the model's effectiveness under varying forecast methods and varying interest rate trends. The results show that the goal programming model outperformed other strategies in most cases.