Title: Hedge ratio estimation and hedging effectiveness: the case of the S&P 500 stock index futures contract

Authors: Dimitris Kenourgios, Aristeidis Samitas, Panagiotis Drosos

Addresses: Department of Economics, University of Athens, 5 Stadiou Street, Office 115, Athens 10562, Greece. ' Department of Business Administration, Business School, University of the Aegean, 6 Christou Lada Street, Office 15, Athens 10561, Greece. ' Department of Economics, University of Sheffield, 9 Mappin Street, Sheffield S1 4DT, UK

Abstract: This paper investigates the hedging effectiveness of the Standard & Poor|s (S&P) 500 stock index futures contract using weekly settlement prices for the period 3 July 1992–30 June 2002. Particularly, it focuses on three areas of interest: the determination of the appropriate model for estimating a hedge ratio that minimises the variance of returns; the hedging effectiveness and the stability of optimal hedge ratios through time and an in-sample forecasting analysis to examine the hedging performance of different econometric methods. The hedging performance of this contract is examined considering alternative methods, both constant and time varying, for computing more effective hedge ratios. The results suggest the optimal hedge ratio that incorporates non-stationarity, long-run equilibrium relationship and short-run dynamics are reliable and useful for hedgers. Comparisons of the hedging effectiveness and in-sample hedging performance of each model imply that the Error Correction Model (ECM) is superior to other models employed in terms of risk reduction. Finally, the results for testing the stability of the optimal hedge ratio obtained from the ECM suggest that it remains stable over time.

Keywords: hedging effectiveness; minimum variance hedge ratio; MVHR; hedging models; Standard and Poor; S&P 500 stock index futures; hedge ratio estimation; risk reduction; risk assessment.

DOI: 10.1504/IJRAM.2008.019316

International Journal of Risk Assessment and Management, 2008 Vol.9 No.1/2, pp.121 - 134

Published online: 07 Jul 2008 *

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