IDEAS home Printed from https://ideas.repec.org/a/wly/jfutmk/v25y2005i10p1011-1024.html
   My bibliography  Save this article

Estimating the optimal hedge ratio with focus information criterion

Author

Listed:
  • Donald Lien
  • Keshab Shrestha

Abstract

In recent years, the error‐correction model without lags has been used in estimating the minimum‐variance hedge ratio. This article proposes the use of the same error‐correction model, but with lags in spot and futures returns in estimating the hedge ratio. In choosing the lag structure, use of the Akaike information criterion (AIC) and recently proposed focus information criterion (FIC) by G. Claeskens and N. L. Hjort (2003) is suggested. The proposed methods are applied to 24 different futures contracts. Even though the FIC hedge ratio is expected to perform better in terms of mean‐squared error, the AIC hedge ratio is found to perform as well as the FIC and better than the simple hedge ratios in terms of hedging effectiveness. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:1011– 1024, 2005

Suggested Citation

  • Donald Lien & Keshab Shrestha, 2005. "Estimating the optimal hedge ratio with focus information criterion," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 25(10), pages 1011-1024, October.
    • Handle: RePEc:wly:jfutmk:v:25:y:2005:i:10:p:1011-1024
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Da‐Hsiang Donald Lien, 1996. "The effect of the cointegration relationship on futures hedging: A note," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 16(7), pages 773-780, October.
    2. Lien, Donald, 2004. "Cointegration and the optimal hedge ratio: the general case," The Quarterly Review of Economics and Finance, Elsevier, vol. 44(5), pages 654-658, December.
    3. Ederington, Louis H, 1979. "The Hedging Performance of the New Futures Markets," Journal of Finance, American Finance Association, vol. 34(1), pages 157-170, March.
    4. Eugene F. Fama & Kenneth R. French, 2015. "Commodity Futures Prices: Some Evidence on Forecast Power, Premiums, and the Theory of Storage," World Scientific Book Chapters, in: Anastasios G Malliaris & William T Ziemba (ed.), THE WORLD SCIENTIFIC HANDBOOK OF FUTURES MARKETS, chapter 4, pages 79-102, World Scientific Publishing Co. Pte. Ltd..
    5. Engle, Robert & Granger, Clive, 2015. "Co-integration and error correction: Representation, estimation, and testing," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 39(3), pages 106-135.
    6. John M. Geppert, 1995. "A statistical model for the relationship between futures contract hedging effectiveness and investment horizon length," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 15(5), pages 507-536, August.
    7. Sheng‐Syan Chen & Cheng‐Few Lee & Keshab Shrestha, 2004. "An empirical analysis of the relationship between the hedge ratio and hedging horizon: A simultaneous estimation of the short‐ and long‐run hedge ratios," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 24(4), pages 359-386, April.
    8. Leland L. Johnson, 1960. "The Theory of Hedging and Speculation in Commodity Futures," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 27(3), pages 139-151.
    9. Mohammad Hashem Pesaran & Yongcheol Shin & Richard J Smith, 1999. "Bounds Testing Approaches to the Analysis of Long Run Relationships," Edinburgh School of Economics Discussion Paper Series 46, Edinburgh School of Economics, University of Edinburgh.
    10. Pesaran, M Hashem, 1997. "The Role of Economic Theory in Modelling the Long Run," Economic Journal, Royal Economic Society, vol. 107(440), pages 178-191, January.
    11. Chen, Sheng-Syan & Lee, Cheng-few & Shrestha, Keshab, 2003. "Futures hedge ratios: a review," The Quarterly Review of Economics and Finance, Elsevier, vol. 43(3), pages 433-465.
    12. Bruce A. Benet, 1992. "Hedge period length and Ex‐ante futures hedging effectiveness: The case of foreign‐exchange risk cross hedges," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 12(2), pages 163-175, April.
    13. A. G. Malliaris & Jorge L. Urrutia, 1991. "The impact of the lengths of estimation periods and hedging horizons on the effectiveness of a Hedge: Evidence from foreign currency futures," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 11(3), pages 271-289, June.
    14. Asim Ghosh, 1993. "Hedging with stock index futures: Estimation and forecasting with error correction model," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 13(7), pages 743-752, October.
    15. Tim Krehbiel & Lee C. Adkins, 1993. "Cointegration tests of the unbiased expectations hypothesis in metals markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 13(7), pages 753-763, October.
    16. Donald Lien & Xiangdong Luo, 1993. "Estimating multiperiod hedge ratios in cointegrated markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 13(8), pages 909-920, December.
    17. Claeskens G. & Hjort N.L., 2003. "The Focused Information Criterion," Journal of the American Statistical Association, American Statistical Association, vol. 98, pages 900-916, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Markopoulou, Chrysi E. & Skintzi, Vasiliki D. & Refenes, Apostolos-Paul N., 2016. "Realized hedge ratio: Predictability and hedging performance," International Review of Financial Analysis, Elsevier, vol. 45(C), pages 121-133.
    2. Donald Lien & Keshab Shrestha & Jing Wu, 2016. "Quantile Estimation of Optimal Hedge Ratio," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 36(2), pages 194-214, February.
    3. Bai, Yujuan & Pan, Zhiyuan & Liu, Li, 2019. "Improving futures hedging performance using option information: Evidence from the S&P 500 index," Finance Research Letters, Elsevier, vol. 28(C), pages 112-117.
    4. Wang Haoyu & Junpeng Di & Qing Han, 2023. "Adaptive hedging horizon and hedging performance estimation," Papers 2302.00251, arXiv.org.
    5. Gurmeet Singh, 2017. "Estimating Optimal Hedge Ratio and Hedging Effectiveness in the NSE Index Futures," Jindal Journal of Business Research, , vol. 6(2), pages 108-131, December.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Ghoddusi, Hamed & Emamzadehfard, Sahar, 2017. "Optimal hedging in the US natural gas market: The effect of maturity and cointegration," Energy Economics, Elsevier, vol. 63(C), pages 92-105.
    2. Bessler, Wolfgang & Wolff, Dominik, 2014. "Hedging European government bond portfolios during the recent sovereign debt crisis," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 33(C), pages 379-399.
    3. Yudong Wang & Chongfeng Wu & Li Yang, 2015. "Hedging with Futures: Does Anything Beat the Naïve Hedging Strategy?," Management Science, INFORMS, vol. 61(12), pages 2870-2889, December.
    4. Jędrzej Białkowski & Martin T. Bohl & Devmali Perera, 2022. "Commodity Futures Hedge Ratios: A Meta-Analysis," Working Papers in Economics 22/12, University of Canterbury, Department of Economics and Finance.
    5. Białkowski, Jędrzej & Bohl, Martin T. & Perera, Devmali, 2023. "Commodity futures hedge ratios: A meta-analysis," Journal of Commodity Markets, Elsevier, vol. 30(C).
    6. Stavros Degiannakis & Christos Floros, 2010. "Hedge Ratios in South African Stock Index Futures," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 9(3), pages 285-304, December.
    7. Bessler, Wolfgang & Leonhardt, Alexander & Wolff, Dominik, 2016. "Analyzing hedging strategies for fixed income portfolios: A Bayesian approach for model selection," International Review of Financial Analysis, Elsevier, vol. 46(C), pages 239-256.
    8. Spencer, Simon & Bredin, Don & Conlon, Thomas, 2018. "Energy and agricultural commodities revealed through hedging characteristics: Evidence from developing and mature markets," Journal of Commodity Markets, Elsevier, vol. 9(C), pages 1-20.
    9. Pablo Urtubia & Alfonso Novales & Andrés Mora-Valencia, 2021. "Cross-Hedging Portfolios in Emerging Stock Markets: Evidence for the LATIBEX Index," Mathematics, MDPI, vol. 9(21), pages 1-19, October.
    10. An-Sing Chen & Yan-Zhen Liu, 2008. "Enhancing hedging performance with the spanning polynomial projection," Quantitative Finance, Taylor & Francis Journals, vol. 8(6), pages 605-617.
    11. Shrestha, Keshab & Subramaniam, Ravichandran & Peranginangin, Yessy & Philip, Sheena Sara Suresh, 2018. "Quantile hedge ratio for energy markets," Energy Economics, Elsevier, vol. 71(C), pages 253-272.
    12. Kotkatvuori-Örnberg, Juha, 2016. "Dynamic conditional copula correlation and optimal hedge ratios with currency futures," International Review of Financial Analysis, Elsevier, vol. 47(C), pages 60-69.
    13. Alizadeh, Amir H. & Huang, Chih-Yueh & van Dellen, Stefan, 2015. "A regime switching approach for hedging tanker shipping freight rates," Energy Economics, Elsevier, vol. 49(C), pages 44-59.
    14. Donald Lien & Keshab Shrestha & Jing Wu, 2016. "Quantile Estimation of Optimal Hedge Ratio," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 36(2), pages 194-214, February.
    15. Chao Jiang & Ira G. Kawaller & Paul D. Koch, 2016. "Designing A Proper Hedge: Theory Versus Practice," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 39(2), pages 123-144, June.
    16. Shashi Gupta & Himanshu Choudhary & D.R. Agarwal, 2017. "Hedging Efficiency of Indian Commodity Futures," Paradigm, , vol. 21(1), pages 1-20, June.
    17. Corbet, Shaen & Hou, Yang (Greg) & Hu, Yang & Oxley, Les, 2022. "The influence of the COVID-19 pandemic on the hedging functionality of Chinese financial markets," Research in International Business and Finance, Elsevier, vol. 59(C).
    18. Turner, Peter A. & Lim, Siew Hoon, 2015. "Hedging jet fuel price risk: The case of U.S. passenger airlines," Journal of Air Transport Management, Elsevier, vol. 44, pages 54-64.
    19. Andrea L. DeMaskey, 1997. "Single and Multiple Portfolio Cross-Hedging with Currency Futures," Multinational Finance Journal, Multinational Finance Journal, vol. 1(1), pages 23-46, March.
    20. Martínez, Beatriz & Torró, Hipòlit, 2015. "European natural gas seasonal effects on futures hedging," Energy Economics, Elsevier, vol. 50(C), pages 154-168.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wly:jfutmk:v:25:y:2005:i:10:p:1011-1024. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: http://www.interscience.wiley.com/jpages/0270-7314/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.