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Time-Varying Hedge Ratios: An Application to the Indian Stock Futures Market

Using different unconditional and conditional versions of the bivariate BEKK-GARCH model of Engle and Kroner, we calculate time-varying hedge ratios for Indian stock futures market involving a cross-section of seven firms across a spectrum of industries. These models are solved not only with the usual square root exponent but also analysed with an unrestricted version where the exponent is set to one. Our results show time-varying hedge ratios with the exponent set to one improve over hedge ratios obtained from the square root exponent setup as well as over static hedge ratios calculated from the error correction types of models. Time-varying optimal hedge ratio calculation in this new framework makes perfect sense in terms of portfolio allocation decision involving individual stock futures.

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Paper provided by Deakin University, Faculty of Business and Law, School of Accounting, Economics and Finance in its series Accounting, Finance, Financial Planning and Insurance Series with number 2006_03.

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Length: 34 pages
Date of creation: 20 Aug 2006
Date of revision:
Handle: RePEc:dkn:acctwp:aef_2006_03
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  1. Baillie, Richard T & Myers, Robert J, 1991. "Bivariate GARCH Estimation of the Optimal Commodity Futures Hedge," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 6(2), pages 109-24, April-Jun.
  2. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
  3. Anil K. Bera & Philip Garcia & Jae-Sun Roh, 1997. "Estimation of Time-Varying Hedge Ratios for Corn and Soybeans: BGARCH and Random Coefficient Approaches," Finance 9712007, EconWPA.
  4. Yeh, Sally C & Gannon, Gerard L, 2000. " Comparing Trading Performance of the Constant and Dynamic Hedge Models: A Note," Review of Quantitative Finance and Accounting, Springer, vol. 14(2), pages 155-60, March.
  5. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
  6. Moschini, GianCarlo & Myers, Robert J., 2002. "Testing for constant hedge ratios in commodity markets: a multivariate GARCH approach," Journal of Empirical Finance, Elsevier, vol. 9(5), pages 589-603, December.
  7. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
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