Will tighter futures price limits decrease hedge effectiveness?
AbstractThe events triggered by the Global Financial Crisis (GFC) have led to calls for the regulation of financial markets. Given that regulation may involve opportunity costs, this paper examines whether tighter futures price limits can reduce the effectiveness of a futures hedge. We propose a new model that uncovers the underlying spot-futures dynamics when futures prices are subject to limits. We use the model to determine the maximum number of limit days that can occur before minimum variance hedging outcomes are adversely affected. Application of this model to the US soybean and corn markets reveals that existing limits do not reduce hedge effectiveness. If the frequency of limit days increases from current levels of 1% to approximately 3–4%, conventional hedging approaches will experience economically and statistically significant increases in portfolio variance. These results are important for hedgers, clearing houses and regulators in light of the recent calls for derivatives regulation.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Banking & Finance.
Volume (Year): 36 (2012)
Issue (Month): 10 ()
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Web page: http://www.elsevier.com/locate/jbf
Price limits; Long memory; Maturity effects; Tobit;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
- C34 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Truncated and Censored Models; Switching Regression Models
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