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Hedging Effectiveness under Conditions of Asymmetry

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Author Info
Cotter, John
Hanly, James

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Abstract

We examine whether hedging effectiveness is affected by asymmetry in the return distribution by applying tail specific metrics to compare the hedging effectiveness of short and long hedgers using Oil futures contracts. The metrics used include Lower Partial Moments (LPM), Value at Risk (VaR) and Conditional Value at Risk (CVAR). Comparisons are applied to a number of hedging strategies including OLS and both Symmetric and Asymmetric GARCH models. Our findings show that asymmetry reduces in-sample hedging performance and that there are significant differences in hedging performance between short and long hedgers. Thus, tail specific performance metrics should be applied in evaluating hedging effectiveness. We also find that the Ordinary Least Squares (OLS) model provides consistently good performance across different measures of hedging effectiveness and estimation methods irrespective of the characteristics of the underlying distribution.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 3501.

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Date of creation: 2007
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Handle: RePEc:pra:mprapa:3501

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Keywords: Hedging Performance Asymmetry Downside Risk Value at Risk Conditional Value at Risk. JEL classification: G10 G12 G15. ____________________________________________________________________ John Cotter Director of Centre for Financial Markets Department of Banking and Finance University College Dublin Blackrock Co. Dublin Ireland tel 353 1 716 8900 e-mail john.cotter@ucd.ie. Jim Hanly School of Accounting and Finance Dublin Institute of Technology tel 353 1 402 3180 e-mail james.hanly@dit.ie. The authors would like to thank the participants at the Global Finance Annual Conference for their constructive comments.

Find related papers by JEL classification:
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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References listed on IDEAS
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    Other versions:
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  7. Price, Kelly & Price, Barbara & Nantell, Timothy J, 1982. " Variance and Lower Partial Moment Measures of Systematic Risk: Some Analytical and Empirical Results," Journal of Finance, American Finance Association, vol. 37(3), pages 843-55, June. [Downloadable!] (restricted)
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    Other versions:
  13. Cecchetti, Stephen G & Cumby, Robert E & Figlewski, Stephen, 1988. "Estimation of the Optimal Futures Hedge," The Review of Economics and Statistics, MIT Press, vol. 70(4), pages 623-30, November. [Downloadable!] (restricted)
    Other versions:
  14. Peter de Goeij, 2004. "Modeling the Conditional Covariance Between Stock and Bond Returns: A Multivariate GARCH Approach," Journal of Financial Econometrics, Oxford University Press, vol. 2(4), pages 531-564. [Downloadable!] (restricted)
  15. Chris Brooks & Olan T. Henry & Gita Persand, 2002. "The Effect of Asymmetries on Optimal Hedge Ratios," Journal of Business, University of Chicago Press, vol. 75(2), pages 333-352, April. [Downloadable!]
  16. Giot, P. & Laurent, S., 2001. "Value-at-risk for Long and Short Trading Positions," Papers 0122, Universite catholique de Louvain - Center for Operations Research and Economics (CORE).
    Other versions:
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