The percentage fluctuations in the prices of Swiss Rolls and Frankfurter Sausage have a correlation coefficient (ρ) of 0.9814, which is quite near to 1. This suggests that the two equities have a very strong positive correlation. Stated differently, the two stocks typically follow the same path of movement. This implies that the price of the Swiss roll is probably going to increase if the price of the Frankfurter sausage does, and vice versa.

 

Due of the strong correlation between the two equities, in order to fully offset any potential losses from the Swiss Roll, you will need to take a relatively significant short position in the Frankfurter Sausage. To fully hedge your position, for instance, you would need to short sell about $98.14 million worth of Frankfurter sausage if you invested $100 million in the Swiss Roll.

 

Of course, if you still think the Swiss Roll is a wise investment, you might not wish to fully hedge your stake. To lessen your exposure to this risk, you can think about opening a short position in the Frankfurter Sausage if you are worried about the possibility of losing money on the Swiss Roll.

Step-by-step explanation

The hedge ratio is quite near to -1, at -0.9814. This indicates that any possible losses from the Swiss Roll would be perfectly compensated by a short position in the Frankfurter Sausage that is 98.14% of the size of the long position in the Swiss Roll.

Stated differently, a 1% decrease in the price of Swiss rolls would result in a 0.9814% increase in the price of Frankfurter sausage. By doing this, the investor would not suffer any losses overall, offsetting the loss in the Swiss Roll.

Of course, if you still think the Swiss Roll is a wise investment, you might not wish to fully hedge your stake. To lessen your exposure to this risk, you can think about opening a short position in the Frankfurter Sausage if you are worried about the possibility of losing money on the Swiss Roll.

 

Here is a table summarizing the key findings:

Statistic Value
Correlation coefficient (ρ) 0.9814
Hedge ratio -0.9814

 

 

As you can see, the hedging ratio is extremely near to -1 and the correlation coefficient between the two equities is very strong. This implies that one way to properly hedge against losses in the Swiss Roll is to take a short position in Frankfurter Sausage.

 

 

 

 

Reference

https://www.investopedia.com/terms/h/hedgeratio.asp

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