CHAPTER 3 Example 3.5 Calculation of the minimimum variance hedge ratio An airline expects to purchase two million gallons of jet fuel in one month and decides to use heating oil futures for hedging. We suppose that Table 3.2 gives, for 15 successive months, data on the change, AS, in the jet fuel price per gallon and the corresponding change, AF, in the futures price for the contract on heating oil that would be used for hedging price changes during the month. To evaluate the minimum variance hedge ratio, we can use the STDEV and CORREL functions in Excel to obtain op = 0.0313, Os = 0.0263, and p=0.928. Equation (3.1) then gives 0.0263 h = 0.928 x -0.7777 0.0313 Alternatively we can use the SLOPE function in Excel to get this answer directly (See worksheet on author's website for the calculations.) This result means that the airline should hedge by taking a position in heating oil futures corresponding to 77.77% of its exposure. The hedge effectiveness is 0.9282 0.862.