Hedging Effectiveness in the Index Futures Market (original) (raw)
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Hedging effectiveness in the index futures markets
2010
This paper addresses the question of how far hedging effectiveness can be improved by the use of more sophisticated models of the relationship between futures and spot prices. Working with daily data from six major index futures markets, we show that, when the cost of carry is incorporated in to the model, the two series are cointegrated, as anticipated. Fitting an ECM with a GJR-GARCH model of the variance process, we derive the implied optimal hedge ratios and compare their out-of-sample hedging effectiveness with OLS-based hedges. The results suggest little or no improvement over OLS.
Hedging effectiveness for international index futures markets
Economics and Business
This paper investigates the hedging effectiveness of the International Index Futures Markets using daily settlement prices for the period 4 January 2010 to 31 December 2015. Standard OLS regressions, Error Correction Model (ECM), as well as Autoregressive Distributed Lag (ARDL) cointegration model are employed to estimate corresponding hedge ratios that can be employed in risk management. The analyzed sample consists of daily closing market rates of the stock market indexes of the USA and the European futures contracts. The findings indicate that the time varying hedge ratios, if estimated through the ARDL model, are more efficient than the fixed hedge ratios in terms of minimizing the risk. Additionally, there is evidence that the comparative advantage of advanced econometric approaches compared to conventional models is enhanced further for capital markets within peripheral EU countries
OPTIMAL HEDGE RATIO AND MODEL SPECIFICATION: EVIDENCE FOR THE S&P 500 STOCK INDEX FUTURES CONTRACT
mfs.rutgers.edu
This paper investigates the hedging effectiveness of the Standard & Poor's (S&P) 500 stock index futures contract using weekly settlement prices for the period July 3 rd , 1992 to June 30 th , 2000. Particularly, it focuses on three areas of interest: the determination of the appropriate model for estimating a hedge ratio that minimizes the variance of returns; the hedging effectiveness and the stability of optimal hedge ratios through time; an in-sample forecasting analysis in order to examine the hedging performance of different econometric methods. The minimum variance hedge ratios (MVHRs) are measured using the OLS regression model, the Error Correction Model, the GARCH model, but also the EGARCH model. The results suggest the optimal hedge ratio that incorporates nonstationarity, long run equilibrium relationship and short run dynamics is reliable and useful for hedgers. Comparisons of the hedging effectiveness and in-sample hedging performance of each model imply that the ECM is superior to the other models employed in terms of risk reduction. Finally, the results for testing the stability of the optimal hedge ratio obtained from the ECM suggest that it remains stable over time.
Speculative Market Efficiency and Hedging Effectiveness of Emerging Chinese Index Futures Market
Journal of Transnational Management, 2011
With the daily sample of CSI300 index and CSI300 index futures prices, we investigate the market efficiency and hedging effectiveness of the Chinese index futures market. Cointegration test is employed to examine the market efficiency; OLS, the symmetric bivariate GARCH, the asymmetric bivariate GARCH and timevarying copulas are used to estimate hedging effectiveness. The result shows that CSI300 index futures prices are cointegrated with spot prices and are unbiased predictors of future spot prices. The hedging effectiveness of CSI300 index futures is about 91%, so it can help investors to avoid the systematic risk in the spot market well. Besides, the hedge ratio conducted by the OLS model is the best-performed in variance reduction, very closely followed by the time-varying copulas. Since the dynamic hedge ratios are less stable and having pronounced fluctuations, the hedgers had to adjust their futures positions. The static OLS hedge strategy might be indeed a good choice considering the high transaction cost.
Some Recent Developments in Futures Hedging
SSRN Electronic Journal, 2000
The use of futures contracts as a hedging instrument has been the focus of much research. At the theoretical level, an optimal hedge strategy is traditionally based on the expected-utility maximization paradigm. A simplification of this paradigm leads to the minimum-variance criterion. Although this paradigm is quite well accepted, alternative approaches have been sought. At the empirical level, research on futures hedging has benefited from the recent developments in the econometrics literature. Much research has been done on improving the estimation of the optimal hedge ratio. As more is known about the statistical properties of financial time series, more sophisticated estimation methods are proposed. In this survey we review some recent developments in futures hedging. We delineate the theoretical underpinning of various methods and discuss the econometric implementation of the methods. . Of course, we are solely responsible for any omissions and commissions.
Short-run deviations and optimal hedge ratio: evidence from stock futures
Journal of Multinational Financial Management, 2003
This paper investigates the effects of the long-run relationship between stock cash index and futures index on the hedging effectiveness of six stock futures markets. Effectiveness of five different hedging ratios depending on different estimation procedures is investigated. The unhedged, the traditional hedge and the minimum variance hedge ratios are all constant while the bivariate GARCH and GARCH-X hedge ratios are time varying. The effectiveness of the hedge ratio is compared by investigating the total sample and the out-of-sample performance of the five ratios. The total sample period consists of daily returns from (1 year). Results show that the time-varying hedge ratio outperforms the constant hedge ratio. #
Hedging performance of volatility index futures: a partial cointegration approach
Review of Quantitative Finance and Accounting
Using the Clegg-Krauss framework, this paper first examines a partial cointegration relationship between stock index futures and VIX futures prices and then constructs a hedging strategy based upon this relationship. This paper argues that the stock index futures and the VIX futures are both affected by unobservable investor sentiment and thus the price series should be modelled by the partial cointegration relationship. Our empirical results validate a partial cointegration relationship between stock index and VIX futures prices. Based upon the partial cointegration relationship between stock index futures and VIX futures prices, we demonstrate that the proposed strategy outperforms conventional strategies, e.g., OLS , VAR , and VECM , in terms of tail risk reduction and expected utility, especially when the length of the hedge horizon increases. In addition, the partial cointegration-based strategy becomes more dominant when the stock index futures price is near its historical high. Overall, our empirical evidence of the hedging effectiveness for different hedge horizons and market timing with VIX futures provides valuable information for practitioners in risk management.
International journal of Banking, Risk and Insurance, 2018
Present study attempts to estimate hedging effectiveness in Indian equity futures market using NIFTY50 index futures and its 17 composite stock futures (out of 50 stocks). The study uses near month futures contracts from their respective date of inception until March 31, 2017. The study applies eight methods, proposed in the literature, to estimate optimal hedge ratio namely; Naïve, Ederington's OLS, ARMA-OLS, VAR, VECM, GARCH, EGARCH, and TARCH. It is observed that OLS hedge ratio provides highest hedging effectiveness, whereas lowest hedging effectiveness is given by Naïve and time-varying models. The above observations imply that constant hedging is more efficient than dynamic hedging which is consistent with the findings of Wang et al (2015) and Bonga and Umoetok (2016).
International Journal of Risk …, 2008
This paper investigates the hedging effectiveness of the Standard & Poor's (S&P) 500 stock index futures contract using weekly settlement prices for the period July 3 rd , 1992 to June 30 th , 2002. Particularly, it focuses on three areas of interest: the determination of the appropriate model for estimating a hedge ratio that minimizes the variance of returns; the hedging effectiveness and the stability of optimal hedge ratios through time; an in-sample forecasting analysis in order to examine the hedging performance of different econometric methods. The hedging performance of this contract is examined considering alternative methods, both constant and time-varying, for computing more effective hedge ratios. The results suggest the optimal hedge ratio that incorporates nonstationarity, long run equilibrium relationship and short run dynamics is reliable and useful for hedgers. Comparisons of the hedging effectiveness and in-sample hedging performance of each model imply that the error correction model (ECM) is superior to the other models employed in terms of risk reduction. Finally, the results for testing the stability of the optimal hedge ratio obtained from the ECM suggest that it remains stable over time.