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Minimum variance hedging when spot price changes are partially predictable

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  • Ederington, Louis H.
  • Salas, Jesus M.

Abstract

In many markets, changes in the spot price are partially predictable. We show that when this is the case: (1) although unbiased, traditional regression estimates of the minimum variance hedge ratio are inefficient, (2) estimates of the riskiness of both hedged and unhedged positions are biased upward, and (3) estimates of the percentage risk reduction achievable through hedging are biased downward. For natural gas cross hedges, we find that both the inefficiency and bias are substantial. We further find that incorporating the expected change in the spot price, as measured by the futures-spot price spread at the beginning of the hedge, into the regression results in a substantial increase in efficiency and reduction in the bias.

Suggested Citation

  • Ederington, Louis H. & Salas, Jesus M., 2008. "Minimum variance hedging when spot price changes are partially predictable," Journal of Banking & Finance, Elsevier, vol. 32(5), pages 654-663, May.
    • Handle: RePEc:eee:jbfina:v:32:y:2008:i:5:p:654-663
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    Cited by:

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    17. Panos K. Pouliasis & Ilias D. Visvikis & Nikos C. Papapostolou & Alexander A. Kryukov, 2020. "A novel risk management framework for natural gas markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(3), pages 430-459, March.
    18. Mihaela NICOLAU & Giulio PALOMBA & Ilaria TRAINI, 2013. "Are Futures Prices Influenced by Spot;Prices or Vice-versa? An Analysis of Crude;Oil, Natural Gas and Gold Markets," Working Papers 394, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
    19. Peña, Juan Ignacio, 2023. "The hedging effectiveness of electricity futures in the Spanish market," Finance Research Letters, Elsevier, vol. 53(C).
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    21. Torro, Hipolit, 2009. "Assessing the influence of spot price predictability on electricity futures hedging," MPRA Paper 18892, University Library of Munich, Germany.
    22. Lee, Hsiang-Tai, 2010. "Regime switching correlation hedging," Journal of Banking & Finance, Elsevier, vol. 34(11), pages 2728-2741, November.

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