Hedge (finance)
investment position intended to offset potential losses or gains that may be incurred by a companion investment
A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, gambles, many types of over-the-counter and derivative products, and futures contracts.
Public futures markets were established in the 19th century to allow transparent, standardized, and efficient hedging of agricultural commodity prices; they have since expanded to include futures contracts for hedging the values of energy, precious metals, foreign currency, and interest rate fluctuations.
Etymology
Hedging is the practice of taking a position in one market to offset and balance against the risk adopted by assuming a position in a contrary or opposing market or investment. The word hedge is from Old English hecg, originally any fence, living or artificial. The first known use of the word as a verb meaning 'dodge, evade' dates from the 1590s; that of 'insure oneself against loss,' as in a bet, is from the 1670s.
Hedge-investment duality
Optimal hedging and optimal investments are intimately connected. It can be shown that one person's optimal investment is another's optimal hedge (and vice versa). This follows from a geometric structure formed by probabilistic representations of market views and risk scenarios. In practice, the hedge-investment duality is related to the widely used notion of risk recycling.
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