Estimating the optimal hedge ratio with focus information criterion

Donald Lien and Keshab Shrestha

Journal of Futures Markets, 2005, vol. 25, issue 10, 1011-1024

Abstract: In recent years, the error‐correction model without lags has been used in estimating the minimum‐variance hedge ratio. This article proposes the use of the same error‐correction model, but with lags in spot and futures returns in estimating the hedge ratio. In choosing the lag structure, use of the Akaike information criterion (AIC) and recently proposed focus information criterion (FIC) by G. Claeskens and N. L. Hjort (2003) is suggested. The proposed methods are applied to 24 different futures contracts. Even though the FIC hedge ratio is expected to perform better in terms of mean‐squared error, the AIC hedge ratio is found to perform as well as the FIC and better than the simple hedge ratios in terms of hedging effectiveness. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:1011– 1024, 2005

Date: 2005
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