18. You are asked to hedge price changes in a security S over a maturity T. The correlations of price changes in S, and price changes in futures contracts F1, F2 are given by the following correlation matrix:
S | F1 | F2 | |
S | 1.00000 | 0.98757 | 0.82923 |
F1 | 0.98757 | 1.00000 | 0.84939 |
F2 | 0.82923 | 0.84939 | 1.00000 |
If the standard deviations of the price changes on the three assets are given by
then, find the minimum-variance hedge for S using both futures contracts F1 and F2. Express your solution in terms of the number of units in the futures contracts F1 and F2 to hedge a 1 unit position in S. What can you say about the solution(s) you have arrived at?
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