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Cross Hedging Stock Sector Risk with Index Futures by Considering the Global Equity Systematic Risk

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  • Wen-Chung Hsu

    (Department of International Business Studies, National Chi Nan University, No.1, University Rd., Puli, Nantou 545, Taiwan)

  • Hsiang-Tai Lee

    (Department of Banking and Finance, National Chi Nan University, No.1, University Rd., Puli, Nantou 545, Taiwan)

Abstract

This article investigates the effectiveness of TAIEX (Taiwan Stock Exchange) futures, Taiwan 50 futures, and nonfinance nonelectronics subindex (NFNE) futures for cross hedging the price risk of stock sector indices traded on the Taiwan stock exchange. A state-dependent volatility spillover GARCH hedging strategy is developed to capture the regime switching global equity volatility spillover effect. Empirical results show that the NFNE futures exhibit superior effectiveness as an instrument for hedging stock sector exposures compared with the TAIEX and Taiwan 50 futures. Simultaneous hedge using both NFNE and MSCI (Morgan Stanley Capital International) world index futures further improves the hedging effectiveness compared with the hedging strategy using only the NFNE futures. This shows the importance of hedging the global equity systematic risk of stock sectors by considering the comovement between domestic and global equity markets.

Suggested Citation

  • Wen-Chung Hsu & Hsiang-Tai Lee, 2018. "Cross Hedging Stock Sector Risk with Index Futures by Considering the Global Equity Systematic Risk," IJFS, MDPI, vol. 6(2), pages 1-17, April.
    • Handle: RePEc:gam:jijfss:v:6:y:2018:i:2:p:44-:d:141779
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    References listed on IDEAS

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    2. Leunglung Chan, 2018. "Editorial for Special Issue “Finance, Financial Risk Management and their Applications”," IJFS, MDPI, vol. 6(4), pages 1-3, October.
    3. Babu Jose & Nithin Jose, 2023. "Is Cross-Hedging Effective for Mitigating Equity Investment Risks in the Indian Banking Sector?," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 30(1), pages 189-210, March.
    4. Lee, Chien-Chiang & Lee, Hsiang-Tai, 2023. "Optimal portfolio diversification with a multi-chain regime-switching spillover GARCH model," Global Finance Journal, Elsevier, vol. 55(C).
    5. Hsiang‐Tai Lee, 2022. "A Markov regime‐switching Cholesky GARCH model for directly estimating the dynamic of optimal hedge ratio," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(3), pages 389-412, March.

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