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Riskiness-minimizing spot-futures hedge ratio

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  • Chen, Yi-Ting
  • Ho, Keng-Yu
  • Tzeng, Larry Y.
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    Abstract

    In this paper, we propose a new spot-futures hedging method that determines the optimal hedge ratio by minimizing the riskiness of hedged portfolio returns, where the riskiness is measured by the index of Aumann and Serrano (2008). Unlike the risk measurements widely used in the literature, the riskiness index employed in our method satisfies monotonicity with respect to stochastic dominance. We also provide an empirical example to demonstrate how to estimate and test this optimal hedge ratio in equity data by the method-of-moments.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 40 (2014)
    Issue (Month): C ()
    Pages: 154-164

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    Handle: RePEc:eee:jbfina:v:40:y:2014:i:c:p:154-164

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Riskiness index; Optimal hedge ratio; Method-of-moments;

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    References

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    1. Chen, Sheng-Syan & Lee, Cheng-few & Shrestha, Keshab, 2003. "Futures hedge ratios: a review," The Quarterly Review of Economics and Finance, Elsevier, Elsevier, vol. 43(3), pages 433-465.
    2. Robert J. Aumann & Roberto Serrano, 2007. "An economic index of riskiness," Working Papers, Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales 2007-08, Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales.
    3. Ederington, Louis H, 1979. "The Hedging Performance of the New Futures Markets," Journal of Finance, American Finance Association, American Finance Association, vol. 34(1), pages 157-70, March.
    4. Jushan Bai & Serena Ng, 2005. "Tests for Skewness, Kurtosis, and Normality for Time Series Data," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 23, pages 49-60, January.
    5. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
    6. Dean Foster & Sergiu Hart, 2007. "An Operational Measure of Riskiness," Levine's Bibliography 843644000000000095, UCLA Department of Economics.
    7. Chris Brooks & Olan T. Henry & Gita Persand, 2002. "The Effect of Asymmetries on Optimal Hedge Ratios," The Journal of Business, University of Chicago Press, vol. 75(2), pages 333-352, April.
    8. Amnon Schreiber, 2012. "An Economic Index of Relative Riskiness," Discussion Paper Series, The Center for the Study of Rationality, Hebrew University, Jerusalem dp597, The Center for the Study of Rationality, Hebrew University, Jerusalem.
    9. Donald W.K. Andrews, 1988. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 877R, Cowles Foundation for Research in Economics, Yale University, revised Jul 1989.
    10. Jondeau, Eric & Rockinger, Michael, 2001. "Gram-Charlier densities," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 25(10), pages 1457-1483, October.
    11. Gallant, A.R. & Tauchen, G., 1988. "Seminonparametric Estimation Of Conditionally Constrained Heterogeneous Processes: Asset Pricing Applications," Papers, Chicago - Graduate School of Business 88-59, Chicago - Graduate School of Business.
    12. Turan G. Bali & Nusret Cakici & Fousseni Chabi-Yo, 2011. "A Generalized Measure of Riskiness," Management Science, INFORMS, INFORMS, vol. 57(8), pages 1406-1423, August.
    13. Howard, Charles T. & D'Antonio, Louis J., 1984. "A Risk-Return Measure of Hedging Effectiveness," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 19(01), pages 101-112, March.
    14. Homm, Ulrich & Pigorsch, Christian, 2012. "Beyond the Sharpe ratio: An application of the Aumann–Serrano index to performance measurement," Journal of Banking & Finance, Elsevier, Elsevier, vol. 36(8), pages 2274-2284.
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    Cited by:
    1. Amine Lahiani & Khaled Guesmi, 2014. "Commodity Price Correlation and Time varying Hedge Ratios," Working Papers 2014-142, Department of Research, Ipag Business School.

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