How Is the ‘Hedge Ratio’ Calculated in a Minimum Variance Hedge?

The minimum variance hedge ratio is calculated to determine the optimal number of futures contracts needed to minimize the variance (risk) of the hedged position. The formula is: Hedge Ratio = (Correlation Coefficient between spot and futures returns) (Standard Deviation of spot returns / Standard Deviation of futures returns).

This ratio ensures that the hedge provides the highest possible reduction in overall price risk.