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Stochastic optimal hedge ratio: theory and evidence

Author

Listed:
  • Abdulnasser Hatemi-J
  • Youssef El-Khatib

Abstract

The minimum variance hedge ratio is widely used by investors to immunize against the price risk. This hedge ratio is usually assumed to be constant across time by practitioners, which might be a too restrictive assumption because the Optimal Hedge Ratio (OHR) might vary across time. In this article we put forward a proposition that a stochastic OHR performs differently than an OHR with constant structure even in the situations in which the mean value of the stochastic OHR is equal to the constant OHR. A mathematical proof is provided for this proposition combined with some simulation results and an application to the US stock market during 1999--2009 using weekly data.

Suggested Citation

  • Abdulnasser Hatemi-J & Youssef El-Khatib, 2012. "Stochastic optimal hedge ratio: theory and evidence," Applied Economics Letters, Taylor & Francis Journals, vol. 19(8), pages 699-703, May.
    • Handle: RePEc:taf:apeclt:v:19:y:2012:i:8:p:699-703
    DOI: 10.1080/13504851.2011.572841
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    Cited by:

    1. Abdulnasser Hatemi-J, 2024. "Testing for the Asymmetric Optimal Hedge Ratios: With an Application to Bitcoin," Papers 2407.19932, arXiv.org, revised Aug 2024.
    2. 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.

    More about this item

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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