Optimal hedging under departures from the cost-of-carry valuation: evidence from the Spanish stock index futures market

Alfonso Novales and Juan Angel Lafuente

Documentos de Trabajo del ICAE from Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico

Abstract: We provide an analytical discussion of the optimal hedge ratio under discrepancies between the futures market price and its theoretical valuation according to the cost-of-carry model. Assuming a geometric Brownian motion for spot prices, we model mispricing as a speci…c noise component in the dynamics of futures market prices. Empirical evidence on the model is provided for the Spanish stock index futures. Ex-ante simulations with actual data reveal that hedge ratios that take into account the estimated, time-varying, correlation between the common and specific disturbances, lead to using a lower number of futures contracts than under a systematic unit ratio, without generally losing hedging e¤ectiveness, while reducing transaction costs and capital requirements. Besides, the reduction in the number of contracts can be substantial over some periods. Finally, a meanvariance expected utility function suggests that the economic benefits from an optimal hedge are substantial.

Keywords: Optimal hedging; Futures contract; Stock Index; GARCH models; Mispricing. (search for similar items in EconPapers)
JEL-codes: C51 G11 G13 (search for similar items in EconPapers)
Pages: pages 27
Date: 2002
New Economics Papers: this item is included in nep-rmg
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Journal Article: Optimal hedging under departures from the cost-of-carry valuation: Evidence from the Spanish stock index futures market (2003)
Working Paper: Optimal hedging under departures from the cost of carry valuation: evidence from the spanish stock index futures market (2000)
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