Combining the Effects of OLS and Spread on Futures Hedging: Evidence from the Taiwan Stock Index

Ting-Yi Wu

Emerging Markets Finance and Trade, 2014, vol. 50, issue S5, 214-228

Abstract: This study proposes a dynamic hedge ratio, the combined ordinary least squares spread (COLSS), which combines the hedge ratio of ordinary least squares and the value of spread. Using this dynamic ratio for hedging with futures contracts, one can replace spot risk with spread risk. The COLSS captures not only the long-run equilibrium between spot and futures returns, but also the short-run deviation from equilibrium. The spread is forecast by one-period lagged stock market factors and high-order moments that are estimated by an options model. In the in-sample and out-of-sample tests, the COLSS strategy achieves significant risk reduction and outperforms the alternative models by a large utility improvement.

Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:mes:emfitr:v:50:y:2014:i:s5:p:214-228

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DOI: 10.2753/REE1540-496X5005S515

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