Short-Run Derivations and Optimal Hedge Ratio: Evidence from Stock Futures

This paper investigates the effects of the long-run relationship between stock cash index and futures index on the hedging effectiveness of six stock futures markets. Effectiveness of five different hedging ratios depending on different estimation procedures is investigated. The unhedged, the traditional hedge and the minimum variance hedge ratios are all constant while the bivariate GARCH and GARCH-X hedge ratios are time varying. The effectiveness of the hedge ratio is compared by investigating the total sample and the out-of-sample performance of the five ratios. The total sample period consists of daily returns from January 1990 to December 1999. Two out-of-sample periods used are from January 1998 to December 1999 (2 years) and from January 1999 to December 1999 (1 year). Results show that the time-varying hedge ratio outperforms the constant hedge ratio.