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Hedging: Scaling and the Investor Horizon

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Author Info

  • John Cotter

    (School of Business, University College Dublin)

  • Jim Hanly

    (School of Accounting and Finance, Dublin Institute of Technology)

Abstract

This paper examines the volatility and covariance dynamics of cash and futures contracts that underlie the Optimal Hedge Ratio (OHR) across different hedging time horizons. We examine whether hedge ratios calculated over a short term hedging horizon can be scaled and successfully applied to longer term horizons. We also test the equivalence of scaled hedge ratios with those calculated directly from lower frequency data and compare them in terms of hedging effectiveness. Our findings show that the volatility and covariance dynamics may differ considerably depending on the hedging horizon and this gives rise to significant differences between short term and longer term hedges. Despite this, scaling provides good hedging outcomes in terms of risk reduction which are comparable to those based on direct estimation.

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File URL: http://www.ucd.ie/geary/static/publications/workingpapers/gearywp201002.pdf
File Function: First version, 2010
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Bibliographic Info

Paper provided by Geary Institute, University College Dublin in its series Working Papers with number 201002.

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Length: 44 pages
Date of creation: 01 Jan 2010
Date of revision:
Handle: RePEc:ucd:wpaper:201002

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Related research

Keywords: Hedging Effectiveness; Scaling; Volatility Modelling; Forecasting;

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Cited by:
  1. Mara Madaleno & Carlos Pinho, 2010. "Hedging Performance and Multiscale Relationships in the German Electricity Spot and Futures Markets," Journal of Risk and Financial Management, MDPI, Open Access Journal, vol. 3(1), pages 26-62, December.

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