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Hedge Effectiveness Forecasting

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  • Dahlgran, Roger A.
  • Ma, Xudong

Abstract

This study focuses on hedging effectiveness defined as the proportionate price risk reduction created by hedging. By mathematical and simulation analysis we determine the following: (a) the regression R2 in the hedge ratio regression will generally overstate the amount of price risk reduction that can be achieved by hedging, (b) the properly computed hedging effectiveness in the hedge ratio regression will also generally overstate the amount of risk reduction that can be achieved by hedging, (c) the overstatement in (b) declines as the sample size increases, (d) application of estimated hedge ratios to non sample data results in an unbiased estimate of hedging effectiveness, (e) application of hedge ratios computed from small samples presents a significant chance of actually increasing price risk by hedging, and (f) comparison of in sample and out of sample hedging effectiveness is not the best method for testing for structural change in the hedge ratio regression.

Suggested Citation

  • Dahlgran, Roger A. & Ma, Xudong, 2008. "Hedge Effectiveness Forecasting," 2008 Conference, April 21-22, 2008, St. Louis, Missouri 37604, NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
  • Handle: RePEc:ags:nccest:37604
    DOI: 10.22004/ag.econ.37604
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    File URL: http://ageconsearch.umn.edu/record/37604/files/confp08-08.pdf
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    References listed on IDEAS

    as
    1. Rahman, Shaikh Mahfuzur & Turner, Steven C. & Costa, Ecio de Farias, 2001. "Cross-Hedging Cottonseed Meal," Journal of Agribusiness, Agricultural Economics Association of Georgia, vol. 19(2), pages 1-9.
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    Keywords

    Agricultural Finance;

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