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Answer: Asset B
## Explanation When hedging using futures on a correlated asset (cross-hedging), the **R² value** from the regression analysis indicates the proportion of variance in the spot price that is explained by the futures price. A higher R² means less basis risk. **Analysis of R² values:** - Asset A: R² = 0.62 (62% variance explained) - Asset B: R² = 0.81 (81% variance explained) **← Highest R²** - Asset C: R² = 0.35 (35% variance explained) - Asset D: R² = 0.45 (45% variance explained) **Key Points:** - Asset B has the highest R² (0.81), meaning it explains 81% of the variance in Zirconium price changes - This indicates the strongest relationship between Asset B and Zirconium - Higher R² = less basis risk in the hedging position - The α and β coefficients are less important than R² for minimizing basis risk Therefore, futures on **Asset B** would introduce the least basis risk.
Author: LeetQuiz Editorial Team
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You wish to hedge an investment in Zirconium using futures. Unfortunately, there are no futures that are based on this asset. To determine the best futures contract for you to hedge with, you run a regression of daily changes in the price of Zirconium against daily changes in the prices of similar assets which do have futures contracts associated with them. Based on your results, futures tied to which asset would likely introduce the least basis risk into your hedging position?
Change in price of Zirconium = α + β (Change in price of Asset)
| Asset | α | β | R² |
|---|---|---|---|
| A | 1.25 | 1.03 | 0.62 |
| B | 0.67 | 1.57 | 0.81 |
| C | 0.01 | 0.86 | 0.35 |
| D | 4.56 | 2.30 | 0.45 |
A
Asset A
B
Asset B
C
Asset C
D
Asset D
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