If changes in spot and futures prices are uncorrelated, then
A) The minimum variance hedge ratio is zero.
B) Basis risk is zero.
C) Hedging the spot position with futures is effective because the portfolio is well-diversified.
D) The minimum variance hedge requires holding equal amounts of spot and futures.

Question

Quizplus · Accepted Answer

If changes in spot and futures prices are uncorrelated, it means that there is no linear relationship between them, making it impossible to effectively hedge using futures. The minimum variance hedge ratio (the ratio of the optimal number of futures contracts to hedge a given amount of spot position) is zero in this case because the relationship between the two prices is non-existent.

If Changes in Spot and Futures Prices Are Uncorrelated, Then