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Optimal hedge ratios and alternative hedging strategies in the presence of cointegrated time-varying risks

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  • Ah-Boon Sim
  • Ralf Zurbruegg
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    Abstract

    This paper utilizes the inter-temporal relationship between the FTSE-100 stock index and its futures price level between 1992 and 1999 to examine the characteristics of several minimum variance hedge ratios and the performances of several alternative hedging strategies for dynamic portfolio management in the presence of cointegrated time-varying risks. Earlier studies neglected the importance of cointegration between the two variables which resulted in biased estimates. These studies, in general, also assume that the hedging period is the same as the estimation time interval. This paper also looks at several key issues when the holding period is longer than the estimation period, such as the construction of optimal minimum variance hedge ratios, and the trade-off between transaction costs and risk reduction.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/13518470110046153
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

    Volume (Year): 7 (2001)
    Issue (Month): 3 ()
    Pages: 269-283

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    Handle: RePEc:taf:eurjfi:v:7:y:2001:i:3:p:269-283

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    Related research

    Keywords: Hedge Ratios Hedging Strategies Cointegrated Time-VARYING Risk Ftse-100;

    References

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    1. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
    2. Ghosh, Asim & Clayton, Ronnie, 1996. "Hedging with International Stock Index Futures: An Intertemporal Error Correction Model," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 19(4), pages 477-91, Winter.
    3. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-31, February.
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    7. Bollerslev, Tim, 1990. "Modelling the Coherence in Short-run Nominal Exchange Rates: A Multivariate Generalized ARCH Model," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 498-505, August.
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    15. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
    16. Garbade, Kenneth D & Silber, William L, 1983. "Price Movements and Price Discovery in Futures and Cash Markets," The Review of Economics and Statistics, MIT Press, vol. 65(2), pages 289-97, May.
    17. Kroner, Kenneth F. & Sultan, Jahangir, 1993. "Time-Varying Distributions and Dynamic Hedging with Foreign Currency Futures," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(04), pages 535-551, December.
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    Cited by:
    1. Patrick McGlenchy & Paul Kofman, 2004. "Structurally Sound Dynamic Index Futures Hedging," Econometric Society 2004 Australasian Meetings 80, Econometric Society.

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