Spot asset carry cost rates and futures hedge ratios

Dean Leistikow (), Ren-Raw Chen () and Yuewu Xu ()
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Dean Leistikow: Fordham University
Ren-Raw Chen: Fordham University
Yuewu Xu: Fordham University

Review of Quantitative Finance and Accounting, 2022, vol. 58, issue 4, No 13, 1779 pages

Abstract: Abstract Since the 1970s, futures hedge ratios have traditionally been calculated ex-post via economically structure-less statistical analyses. This paper proposes an ex-ante, more efficient, computationally simpler, general “carry cost rate” hedge ratio. The proposed hedge ratio is biased, but its bias is readily mitigatable via a stationary Bias Adjustment Multiplier (BAM). The 2-part intuition for the BAM and its stationarity is as follows. First, the paper reasons that the “traditional” hedge ratio should uncover the carry cost rate and shows that it does, albeit inefficiently. Then, since both the “traditional” and “carry cost rate” hedge ratios are driven by the carry cost rate, it may be that their ratio (for implementation in the same prior periods) is stationary and useful as an ex-ante BAM for the “carry cost rate” hedge ratio; the paper tests these conjectures and finds support for both. Specifically, the paper shows that the “bias-adjusted carry cost rate” hedge ratio, defined as the average product of the ex-post BAMs from prior periods and the current ex-ante “carry cost rate” hedge ratio, has higher hedge-effectiveness than that for either the “traditional” or “naive” benchmark hedge ratios in diverse real and simulated markets.

Keywords: Carry cost rate; Ex-ante futures hedge ratio; Ex-post hedge ratio (search for similar items in EconPapers)
JEL-codes: G11 G13 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s11156-022-01037-z

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