I'm interested to hear thoughts from others about the optimal approach for calculating a hedge ratio (HR) between two trading instruments. HR's are useful for basic hedging, as well as pair and spread trading. There are multiple considerations for futures and other derivative contracts based on their specs. So let's keep this simple by limiting the scope of our discussion to two stocks or ETF's, and assume both are priced in USD. To start this off, here are my thoughts: 1. It's simple enough to calculate dollar equivalence by taking a ratio of the nominal prices of both stocks. There's not much more to say on this point. 2. The HR should also adjust for relative volatility of the two stocks. This is really the focus of our discussion. 3. Common statistics like Beta can be calculated for any two stocks. This is a reasonable approach to adjust for volatility. Here are some considerations for Beta: 3a. Beta is normally reported between a stock and the broad market, specifically the S&P500 index. However, using the Beta formula we can calculate Beta for any two price series to give us a measure of relative co-movement. 3b. The lookback period must be specified to calculate Beta. Most websites that report Beta use a long lookback period of 3 to 5 years. A shorter term hedge may prefer a shorter lookback period, perhaps measured in days or weeks depending on your holding period. 3c. Beta only uses the closing price. If you wanted to capture the volatility of high and low prices, another approach must be used (e.g., ATR). Looking forward to comments from others on this topic.