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Structurally Sound Dynamic Index Futures Hedging

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  • Patrick McGlenchy
  • Paul Kofman

Abstract

Portfolio managers use index futures for a variety of reasons. Regardless of their motivation, they will keep a close eye on the relation between the futures and their stock portfolio returns. Whenever this relation is perceived to have changed, the manager will decide whether it is worthwhile to rebalance the portfolio mix. Exact measures as to when and how much rebalancing should occur, have not yet been established. This paper proposes a heuristic algorithm to dynamically update hedged portfolios. This dynamic hedging algorithm is based on a Reverse Order Cusumsquare (ROC) testing procedure, proposed by Pesaran and Timmermann (2002), to optimally determine forecast estimation windows. In a comparison with standard alternatives (expanding window, EWLS window and rolling window), we find significant improvements in hedging performance, both in- and out-of-samp

Suggested Citation

  • Patrick McGlenchy & Paul Kofman, 2004. "Structurally Sound Dynamic Index Futures Hedging," Econometric Society 2004 Australasian Meetings 80, Econometric Society.
    • Handle: RePEc:ecm:ausm04:80
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    References listed on IDEAS

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    More about this item

    Keywords

    reverse order cusum-square test; index futures hedging;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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