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Hedge ratio estimation and hedging effectiveness: the case of the S&P 500 stock index futures contract

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Author Info

  • Dimitris Kenourgios

    (University of Athens)

  • Aristeidis Samitas

    (University of Aegean)

  • Panagiotis Drosos

    (University of Sheffield)

Abstract

This paper investigates the hedging effectiveness of the Standard & Poor’s (S&P) 500 stock index futures contract using weekly settlement prices for the period July 3rd, 1992 to June 30th, 2002. Particularly, it focuses on three areas of interest: the determination of the appropriate model for estimating a hedge ratio that minimizes the variance of returns; the hedging effectiveness and the stability of optimal hedge ratios through time; an in-sample forecasting analysis in order to examine the hedging performance of different econometric methods. The hedging performance of this contract is examined considering alternative methods, both constant and time-varying, for computing more effective hedge ratios. The results suggest the optimal hedge ratio that incorporates nonstationarity, long run equilibrium relationship and short run dynamics is reliable and useful for hedgers. Comparisons of the hedging effectiveness and in-sample hedging performance of each model imply that the error correction model (ECM) is superior to the other models employed in terms of risk reduction. Finally, the results for testing the stability of the optimal hedge ratio obtained from the ECM suggest that it remains stable over time.

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File URL: http://128.118.178.162/eps/fin/papers/0512/0512018.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0512018.

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Length: 23 pages
Date of creation: 19 Dec 2005
Date of revision:
Handle: RePEc:wpa:wuwpfi:0512018

Note: Type of Document - pdf; pages: 23
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Web page: http://128.118.178.162

Related research

Keywords: Hedging effectiveness; minimum variance hedge ratio (MVHR); hedging models; Standard & Poor’s 500 stock index futures;

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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.
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Cited by:
  1. John Hua Fan & Eduardo Roca & Alexandr Akimov, 2010. "Hedging With Futures Contract: Estimation and Performance Evaluation of Optimal Hedge Ratios in the European Union Emissions Trading Scheme," Discussion Papers in Finance finance:201009, Griffith University, Department of Accounting, Finance and Economics.
  2. Matteo Manera & Elisa Scarpa, 2006. "Pricing and Hedging Illiquid Energy Derivatives:an Application to the JCC Index," Working Papers 2006.130, Fondazione Eni Enrico Mattei.

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