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Minimum Variance Hedging and Stock Index Market Efficiency

Author

Listed:
  • Carol Alexander

    (ICMA Centre, University of Reading)

  • Andreza Barbosa

    (ICMA Centre, University of Reading)

Abstract

This empirical study examines the impact of both advanced electronic trading platforms and index exchange traded funds (ETFs) on the minimum variance hedging of stock indices with futures. Our findings show that minimum variance hedging may provide an out-of-sample hedging performance that is superior to that of the one-one futures hedge, but only in markets without active trading of ETFs and advanced development of electronic communications networks. However there is no evidence to suggest that complex econometric models that include, for instance, time varying conditional covariances and error correction can improve on the simple ordinary least squares hedge ratio. Furthermore, in markets with actively traded index ETFs and where electronic trading has become established, no significant efficiency gains are apparent from any minimum variance hedge.

Suggested Citation

  • Carol Alexander & Andreza Barbosa, 2006. "Minimum Variance Hedging and Stock Index Market Efficiency," ICMA Centre Discussion Papers in Finance icma-dp2006-04, Henley Business School, University of Reading, revised Sep 2006.
    • Handle: RePEc:rdg:icmadp:icma-dp2006-04
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    File URL: http://www.icmacentre.ac.uk/pdf/discussion/DP2006-04.pdf
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Minimum variance; futures hedging; stock indices; exchange traded funds; electronic trading; conditional effectivementss mearure;
    All these keywords.

    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)
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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