Hedging Effectiveness of Constant and Time Varying Hedge Ratio in Indian Stock and Commodity Futures Markets

Pandey Ajay

No 2008-06-01, IIMA Working Papers from Indian Institute of Management Ahmedabad, Research and Publication Department

Abstract: This paper examines hedging effectiveness of futures contract on a financial asset and commodities in Indian markets. In an emerging market context like India, the growth of capital and commodity futures market would depend on effectiveness of derivatives in managing risk. For managing risk, understanding optimal hedge ratio is critical for devising effective hedging strategy. We estimate dynamic and constant hedge ratio for S&P CNX Nifty index futures, Gold futures and Soybean futures. Various models (OLS, VAR, and VECM) are used to estimate constant hedge ratio. To estimate dynamic hedge ratios, we use VAR-MGARCH. We compare in-sample and out-of-sample performance of these models in reducing portfolio risk. It is found that in most of the cases, VAR-MGARCH model estimates of time varying hedge ratio provide highest variance reduction as compared to hedges based on constant hedge ratio. Our results are consistent with findings of Myers (1991), Baillie and Myers (1991), Park and Switzer (1995a,b), Lypny and Powella (1998), Kavussanos and Nomikos (2000), Yang (2001), and Floros and Vougas (2006).

Keywords: Hedging Effectiveness; Hedge ratio; Bivariate GARCH; S&P CNX Nifty index and futures; Commodity futures (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cwa and nep-rmg
Date: 2008-06-09

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