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Hedging with Futures: Does Anything Beat the Naïve Hedging Strategy?

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  • Yudong Wang

    () (Antai College of Economics and Management, Shanghai Jiao Tong University, Shanghai 200052, China)

  • Chongfeng Wu

    () (Antai College of Economics and Management, Shanghai Jiao Tong University, Shanghai 200052, China)

  • Li Yang

    () (School of Banking and Finance, University of New South Wales, Sydney, New South Wales 2052, Australia)

Abstract

This paper investigates out-of-sample performance of the naïve hedging strategy relative to that of the minimum variance hedging strategy, in which the covariance parameters are estimated from 18 econometric models. Hedging performance is compared across 24 futures markets. Our main findings suggest that it is difficult to find a strategy under the minimum variance framework that outperforms the naïve hedging strategy both consistently and significantly. Our findings are robust to different sample periods, estimation windows, and hedging horizons and can be partly explained by the effects of estimation error and model misspecification.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2014.2028 . This paper was accepted by Itay Goldstein, finance.

Suggested Citation

  • Yudong Wang & Chongfeng Wu & Li Yang, 2015. "Hedging with Futures: Does Anything Beat the Naïve Hedging Strategy?," Management Science, INFORMS, vol. 61(12), pages 2870-2889, December.
  • Handle: RePEc:inm:ormnsc:v:61:y:2015:i:12:p:2870-2889
    DOI: 10.1287/mnsc.2014.2028
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    File URL: http://dx.doi.org/10.1287/mnsc.2014.2028
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    5. Michael Curran & Ryan Zalla, 2020. "Can Volatility Solve the Naive Portfolio Puzzle?," Papers 2005.03204, arXiv.org, revised Aug 2020.
    6. Gong, Xu & Lin, Boqiang, 2019. "Modeling stock market volatility using new HAR-type models," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 516(C), pages 194-211.
    7. Gong, Xu & Lin, Boqiang, 2018. "Structural changes and out-of-sample prediction of realized range-based variance in the stock market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 494(C), pages 27-39.
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    11. Ahmad Bash & Abdullah M. Al-Awadhi & Fouad Jamaani, 2016. "Measuring the Hedge Ratio: A GCC Perspective," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 8(7), pages 1-1, July.
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    13. Wang, Yudong & Geng, Qianjie & Meng, Fanyi, 2019. "Futures hedging in crude oil markets: A comparison between minimum-variance and minimum-risk frameworks," Energy, Elsevier, vol. 181(C), pages 815-826.
    14. Yan, Cheng & Zhang, Huazhu, 2017. "Mean-variance versus naïve diversification: The role of mispricing," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 48(C), pages 61-81.
    15. Bai, Yujuan & Pan, Zhiyuan & Liu, Li, 2019. "Improving futures hedging performance using option information: Evidence from the S&P 500 index," Finance Research Letters, Elsevier, vol. 28(C), pages 112-117.
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