In linguistics, a word or phrase used to weaken the truth value of an utterance, or to use such a word or phrase. For instance, compare the sentences

"I don't think I'm going." and "I'm not going."

The former hedges the meaning of the latter. Hedges are often used to be polite, in order to soften a verbal blow to the ego or somehow diminish the message that the person being addressed isn't going to get what they want in a certain situation. (Many a semantics or pragmatics textbook will tell you that most verbal expressions of politeness come down to one of these two.)

Frequently-used hedges include: I think, I guess, maybe, perhaps, kind of, sort of, technically, somewhat, rather, and most of the modal auxiliaries (can/could, may/might, will/would, etc.) The list goes on and on: some people who can't stand the insertion of "like" and "y'know" argue that these function as hedges (though generally they don't use linguistics terminology, but rather complain that these make a speaker sound ignorant or unconfident. See people who abuse the word like for examples and discussion of this phenomenon.)

Interestingly, many hedges may at first seem to function as intensifiers (words or phrases which serve to strengthen the truth value of an utterance). Ask yourself which of the following sentences seems stronger:

"I love you." or "I really love you."

Answer (of course, language use is way subjective, but for the purposes of this exercise I'm going to pretend what I'm saying is absolute truth): "I love you." is stronger, because there's something sketchy about having to add an intensifier to a declaration of love. Or maybe I'm reading into things too much... but hey, that's why I'm a linguist.

Semanticians love hedges, because they're a semi-quantifiable sociolinguistic variable. In other words, after a bit of study, it's possible to develop a metric for evaluating the effects of a hedge, and apply predicate or fuzzy logic, and have real computational models to play with.

Hedges are often discussed in the study of language and gender. Traditionally, real men don't hedge, or at least avoid doing so like the plague. Is this a stereotype? Sure, but something rings true about it, because John Gray made his name selling tripe like this in his Mars and Venus series.


One of the words you will hear most on a trading floor is the word hedge. A hedge, quite simply, is some way to reduce or remove the unwanted risk of a position, like hedging a bet. A proverb among trades is that "The only perfect hedge is in a Japanese garden". Although I cannot comment on Japanese horticulture, I can comment on the quality of some hedges, so that is what I will do. I will then explain why a hedge is very important in finance.

Basis risk

If you have a position in one asset, and do a trade in the same asset that perfectly compensates this position, one could say one has a perfect hedge. However, this is commonly just known as having no position. As such, having a hedge position almost by definition implies that the hedge is not perfect; a perfect hedge is not called a hedge, but a flat position. However, when a hedge is not perfect, we introduce basis risk.

Basis risk has its own node, but in principle, it just means that there is a remaining position. Consider, for instance, that one has a position in oil to be delivered in Europe. Now, for some reason, this is hedged with oil to be delivered in Oklahoma. This normally is a very good hedge - unless for some reason, the cost of transport between Europe and Oklahoma skyrockets.

Basis risk can be subtle or obvious, and large or small. People have been killed - even literally - by the smallest of basis risks, such as a difference between the A and B shares of a company, in which the A shares have options on them but the B shares don't, but are otherwise identical. Especially combined with liquidity risk, a basis risk can be devastating.

Static versus dynamic hedging

There are hedges that you can do and then forget about. For instance, the oil hedge I just mentioned is one you could probably just forget about (unless the basis risk kicks in, but then it's probably too late to do anything about it). These are probably the most "obvious" examples of hedges.

There are, however, also products which require dynamic hedging. An example of this are options. Without going too much into detail about the fine art of hedging options, we can state than an option is the right to buy or put a share (or other underlying) at a certain price, known as the strike, and before a certain time. This time is called the expiration The owner of a call will buy the share if it is above the strike at expiration, because that would lock in a profit. If it were below the strike, he would do nothing. So, if you have a clue on the chance you are actually going to buy or sell that share, you might as well buy or sell those shares beforehand, right? Imagine, for instance, that I have a 1050 call on the S&P 500 index, which is today trading at 1090. This call will expire in 2 years. Well, I think it's fair to say that we have about a roughly even chance that it will end above 1000 - perhaps a little bit more than even - so we might sell 50 or 55 shares. However, if the option expires tomorrow, we are almost sure to exercise and we might sell 95 or 100 shares.

Now, there obviously has been a transition between the 50 or 55 shares sold initially and the 95 or 100 shares sold eventually. This means we would have had to adjust our hedge. This would, incidentally, also be the case if the value of the S&P 500 would have changed. If the S&P 500 drops, we should buy shares, and if it were to go up, we would sell shares.

The above example, which is oversimplified - the actual hedge of an option is a lot more complex to compute - is but one example of a case in which dynamic hedging is necessary. It is noted that dynamic hedges are in a sense never very good. The hedge might turn out to be bad in the near or far future, and in the mean while, it was not optimal.

Hedging only unwanted risk

Okay, so we have seen it is possible to hedge a risk. By choosing an appropriate hedge, it is possible to only have exposure to one specific risk. Consider, for instance, an investor that thinks that Exxon will outperform the general market. Of course, she could buy Exxon shares. However, if the entire stock market tanks, she could, even if Exxon does relatively well. A possibility is to sell a basket of other stocks to remove this risk, for instance by selling an index. For example, she could sell the S&P 500 index, which is a broad index of large US companies. This should be a good hedge.

It is even possible she has a more narrow vision, namely that Exxon will outperform other oil companies. In this case, she could sell (go short) other oil companies, such as Royal Dutch Shell, Gazprom and Petrobras. By a proper choice of hedge, one can tailor the exposure one has. In fact, the basis risk is something which is deliberately chosen. As such, an investor does not consider it a risk in the sense that it is an undesirable risk. With good hedging, it should be possible to just have exposure to the one variable one hopes to profit from, such as the relative performance of oil stocks, India versus China, or Euro versus dollar.

Hedges in finance

This, however, is not the only reason why a hedge is important. Consider, for instance, a structured product. This product has the following payoff:

  • 1000 if the S&P 500 is at or below 1000 in one year
  • The value of the S&P if it is between 1000 and 1250 in one year
  • 1250 if the S&P is at or above 1250 in one year.
Such products are very popular in Europe. What should one pay for this? Well, this product essentially consists of a risk reversal, a long put and a short call, and the S&P 500 index. This put and this call are liquid products, that have a well-defined price. As this product can be replicated exactly using the call, the put and the index, its price is simply equal to the price of the long put, the index, minus the premium received for the short call. More importantly, it can be (nearly) exactly replicated. As such, a bank can issue these products, hedge them, and if they are sold for more than the value of the hedge, they pocket the difference, with essentially no risk. The people that sold the put and bought the call have the risk, and they have their own way of hedging it.

This is a general principle: if a product can be created from a combination of other products, it can be hedged by buying these other product if one sells the product. As such, its value is uniquely determined by the value of the hedge. This principle is the cornerstone of the valuation of all derivatives.


A hedge is a trade that reduces the risk of a position. In general, a hedge is understood to only remove part of the risk; if the exact same asset is used, a perfect risk reduction is achieved, but this is called closing rather than hedging a position.

Hedging is important for managing risk. It can be used to obtain an exposure to only the desired part of a position, for instance an exposure to the relative performance of an oil company by hedging the general performance of the stock market by selling the index. Hedging can also be used to value derivatives; the price of a derivative is equal to the (expected) cost of hedging it.

Hedge (?), n. [OE. hegge, AS. hecg; akin to haga an inclosure, E. haw, AS. hege hedge, E. haybote, D. hegge, OHG. hegga, G. hecke. &root;12. See Haw a hedge.]

A thicket of bushes, usually thorn bushes; especially, such a thicket planted as a fence between any two portions of land; and also any sort of shrubbery, as evergreens, planted in a line or as a fence; particularly, such a thicket planted round a field to fence it, or in rows to separate the parts of a garden.

The roughest berry on the rudest hedge. Shak.

Through the verdant maze Of sweetbrier hedges I pursue my walk. Thomson.

Hedge, when used adjectively or in composition, often means rustic, outlandish, illiterate, poor, or mean; as, hedge priest; hedgeborn, etc.

Hedge bells, Hedge bindweed Bot., a climbing plant related to the morning-glory (Convolvulus sepium). -- Hedge bill, a long-handled billhook. -- Hedge garlic Bot., a plant of the genus Alliaria. See Garlic mustard, under Garlic. -- Hedge hyssop Bot., a bitter herb of the genus Gratiola, the leaves of which are emetic and purgative. -- Hedge marriage, a secret or clandestine marriage, especially one performed by a hedge priest. [Eng.] -- Hedge mustard Bot., a plant of the genus Sisymbrium, belonging to the Mustard family. -- Hedge nettle Bot., an herb, or under shrub, of the genus Stachys, belonging to the Mint family. It has a nettlelike appearance, though quite harmless. -- Hedge note. (a) The note of a hedge bird. (b) Low, contemptible writing. [Obs.] Dryden. -- Hedge priest, a poor, illiterate priest. Shak. -- Hedge school, an open-air school in the shelter of a hedge, in Ireland; a school for rustics. -- Hedge sparrow Zool., a European warbler (Accentor modularis) which frequents hedges. Its color is reddish brown, and ash; the wing coverts are tipped with white. Called also chanter, hedge warbler, dunnock, and doney. -- Hedge writer, an insignificant writer, or a writer of low, scurrilous stuff. [Obs.] Swift. -- To breast up a hedge. See under Breast. -- To hang in the hedge, to be at a standstill. "While the business of money hangs in the hedge."



© Webster 1913.

Hedge (?), v. t. [imp. & p. p. Hedged (?); p. pr. & vb. n. Hedging.]


To inclose or separate with a hedge; to fence with a thickly set line or thicket of shrubs or small trees; as, to hedge a field or garden.


To obstruct, as a road, with a barrier; to hinder from progress or success; -- sometimes with up and out.

I will hedge up thy way with thorns. Hos. ii. 6.

Lollius Urbius . . . drew another wall . . . to hedge out incursions from the north. Milton.


To surround for defense; to guard; to protect; to hem (in).

"England, hedged in with the main."



To surround so as to prevent escape.

That is a law to hedge in the cuckoo. Locke.

To hedge a bet, to bet upon both sides; that is, after having bet on one side, to bet also on the other, thus guarding against loss.


© Webster 1913.

Hedge, v. i.


To shelter one's self from danger, risk, duty, responsibility, etc., as if by hiding in or behind a hedge; to skulk; to slink; to shirk obligations.

I myself sometimes, leaving the fear of God on the left hand and hiding mine honor in my necessity, am fain to shuffle, to hedge and to lurch. Shak.

2. Betting

To reduce the risk of a wager by making a bet against the side or chance one has bet on.


To use reservations and qualifications in one's speech so as to avoid committing one's self to anything definite.

The Heroic Stanzas read much more like an elaborate attempt to hedge between the parties than . . . to gain favor from the Roundheads. Saintsbury.


© Webster 1913.

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