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Futures hedging when the structure of the underlying asset changes: The case of the BIFFEX contract

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  • Manolis G. Kavussanos
  • Nikos K. Nomikos

Abstract

This article is concerned with the hedging effectiveness of futures contracts whose underlying asset is an index, when the structure of this index is changing. The case of the freight futures (BIFFEX) contract is examined here. Investigation of this issue is particularly interesting as the composition of its underlying asset, the Baltic Freight Index (BFI), has been revised on a number of occasions in order to improve the hedging performance of the market; previous empirical evidence on the market indicates substantially lower variance reduction (4–19%), compared to other markets (up to 98%). The BFI is a weighted average dry‐cargo freight rate index, compiled from actual freight rates on 11 shipping routes that are dissimilar in terms of vessel sizes and transported commodities. The hedging effectiveness of the market is investigated using both constant and time‐varying hedge ratios, estimated through bivariate error correction GARCH models. Our results indicate that the effectiveness of the BIFFEX contract as a centre for risk management has strengthened over the recent years as a result of the more homogeneous composition of the index. This by itself indicates that the latest restructuring of the index, in November 1999, which is aimed at increasing its homogeneity even further, is likely to have a beneficial impact on the market. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:775–801, 2000

Suggested Citation

  • Manolis G. Kavussanos & Nikos K. Nomikos, 2000. "Futures hedging when the structure of the underlying asset changes: The case of the BIFFEX contract," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 20(8), pages 775-801, September.
  • Handle: RePEc:wly:jfutmk:v:20:y:2000:i:8:p:775-801
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    Cited by:

    1. Jian Yang & Titus Awokuse, 2003. "Asset storability and hedging effectiveness in commodity futures markets," Applied Economics Letters, Taylor & Francis Journals, vol. 10(8), pages 487-491.
    2. Koekebakker, Steen & Adland, Roar & Sødal, Sigbjørn, 2007. "Pricing freight rate options," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 43(5), pages 535-548, September.
    3. repec:eee:transe:v:115:y:2018:i:c:p:164-212 is not listed on IDEAS
    4. repec:eee:transe:v:104:y:2017:i:c:p:150-164 is not listed on IDEAS
    5. Alizadeh, Amir H. & Huang, Chih-Yueh & van Dellen, Stefan, 2015. "A regime switching approach for hedging tanker shipping freight rates," Energy Economics, Elsevier, vol. 49(C), pages 44-59.
    6. repec:eee:ecmode:v:70:y:2018:i:c:p:97-114 is not listed on IDEAS
    7. repec:eee:finana:v:54:y:2017:i:c:p:176-191 is not listed on IDEAS
    8. Adland, Roar & Cariou, Pierre & Wolff, Francois-Charles, 2017. "What makes a freight market index? An empirical analysis of vessel fixtures in the offshore market," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 104(C), pages 150-164.
    9. Steen Koekebakker * & Roar Os Ådland, 2004. "Modelling forward freight rate dynamics—empirical evidence from time charter rates," Maritime Policy & Management, Taylor & Francis Journals, vol. 31(4), pages 319-335, October.
    10. repec:pal:marecl:v:19:y:2017:i:2:d:10.1057_s41278-016-0053-5 is not listed on IDEAS
    11. repec:eee:transa:v:110:y:2018:i:c:p:274-290 is not listed on IDEAS
    12. repec:eee:transe:v:118:y:2018:i:c:p:20-33 is not listed on IDEAS

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