Suppose you want to hedge a futures contract A with another futures contract B. You calculate the minimum-variance hedge ratio ignoring daily resettlement (for example, by regressing daily changes in Contract A's prices on daily changes in Contract B's prices). Suppose, however, that both contracts are marked-to-market daily. Which of the following statements is always true?
A) The tailed hedge ratio is lower than the untailed one.
B) The tailed hedge ratio is equal to the untailed one.
C) The tailed hedge ratio is greater than the untailed one.
D) None of the above is always true.

Question

Quizplus · Accepted Answer

If both futures contracts are marked-to-market daily, the futures prices will be adjusted each day to reflect the current price of the underlying asset. Therefore, the minimum-variance hedge ratio calculated without considering daily resettlement (untailored) would be the same as the one calculated with daily resettlement (tailed). Thus, the tailed hedge ratio is equal to the untailed one.

Suppose You Want to Hedge a Futures Contract a with Another