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Basis Convergence and Long Memory in Volatility When Dynamic Hedging with Futures

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  • Dark, Jonathan

Abstract

When market returns follow a long memory volatility process, standard approaches to estimating dynamic minimum variance hedge ratios (MVHRs) are misspecified. Simulation results and an application to the S&P 500 index document the magnitude of the misspecification that results from failure to account for basis convergence and long memory in volatility. These results have important implications for the estimation of MVHRs in the S&P 500 example and other markets as well.

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  • Dark, Jonathan, 2007. "Basis Convergence and Long Memory in Volatility When Dynamic Hedging with Futures," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(04), pages 1021-1040, December.
  • Handle: RePEc:cup:jfinqa:v:42:y:2007:i:04:p:1021-1040_00
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    Cited by:

    1. Dungey, Mardi & Henry, Olan T & Hvodzdyk, Lyudmyla, 2013. "The impact of jumps and thin trading on realized hedge ratios," Working Papers 2013-02, University of Tasmania, Tasmanian School of Business and Economics, revised 28 Mar 2013.
    2. Gündüz, Yalin & Kaya, Orcun, 2013. "Sovereign default swap market efficiency and country risk in the eurozone," Discussion Papers 08/2013, Deutsche Bundesbank.
    3. Liu, Xiaochun & Jacobsen, Brian, 2011. "The Dynamic International Optimal Hedge Ratio," MPRA Paper 35260, University Library of Munich, Germany.
    4. Dark, Jonathan, 2015. "Futures hedging with Markov switching vector error correction FIEGARCH and FIAPARCH," Journal of Banking & Finance, Elsevier, vol. 61(S2), pages 269-285.
    5. Thomas Conlon & John Cotter & Ramazan Gencay, 2012. "Commodity futures hedging, risk aversion and the hedging horizon," Working Papers 201218, Geary Institute, University College Dublin.
    6. Gündüz, Yalin & Kaya, Orcun, 2014. "Impacts of the financial crisis on eurozone sovereign CDS spreads," Journal of International Money and Finance, Elsevier, vol. 49(PB), pages 425-442.
    7. Dark, Jonathan, 2012. "Will tighter futures price limits decrease hedge effectiveness?," Journal of Banking & Finance, Elsevier, vol. 36(10), pages 2717-2728.

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