Open Access
Subscription Access
Open Access
Subscription Access
Estimation of Hedging Effectiveness Using Variance Reduction and Risk-return Approaches:Evidence From National Stock Exchange of India
Subscribe/Renew Journal
Present study estimates the hedging effectiveness by applying variance-reduction framework and risk-return framework using near month contracts of three benchmark indices (NIFTY50, NIFTYIT, and BANKNIFTY) traded at National Stock Exchange of India (NSE) for the sample period from June 2000 to March 31, 2017 by using nine optimal hedge ratio models. Out of these nine models, six are constant hedging models and three are time-varying hedging models. The study finds that using variance-reduction framework, highest hedging effectiveness is achieved using Ordinary Least Square model; whereas, 1:1 naïve hedge ratio gives lowest hedging effectiveness. On the other hand, when hedging effectiveness is estimated in a risk-return framework, naïve hedge ratio gives highest hedging effectiveness; whereas, OLS gives the least estimate. Secondly, the coefficients of both optimal hedge ratio as well as hedging effectiveness have increased during post-crisis period implying an increase in the cost of hedging. These findings suggests that conventional hedging models are more efficient than highly complicated time-varying hedging models for estimating optimal hedge ratio, these findings are consistent with the findings of Lien (2005), Bhaduri and Durai (2007), Bhargava (2007), Mandal (2011), Wang et al. (2015).
Keywords
Hedging Effectiveness, Optimal Hedge Ratio, Equity Futures Market, Generalized Auto-Regressive Conditional Heteroscedasticity (GARCH), Constant Hedge Ratio, Time-Varying Hedge Ratio.
Subscription
Login to verify subscription
User
Font Size
Information
- Awang, N., Azizan, N. A., Ibrahim, I., & Said, R. M.(2014). Hedging effectiveness stock index futures market:An analysis on malaysia and singapore futures markets. Recent Advances in Economics, Management and Development, pp. 24-34.
- Basher, S. B., & Sadorsky, P. (2016). Hedging emerging market stock prices with oil, gold, VIX, and bonds: A comparison between DCC, ADCC and GOGARCH.Energy Economics, 54, 235-247.
- Bekkerman, A. (2011). Time-varying hedge ratios in linked agricultural markets. Agricultural Finance Review, 71(2), 179-200.
- Bhaduri, S. N., & Durai, S. R. S. (2008). Optimal hedge ratio and hedging effectiveness of stock index futures: Evidence from India. Macroeconomics and Finance in Emerging Market Economies, 1(1), 121-134.
- Bhargava, V., & Malhotra, D. K. (2007). Determining the optimal hedge ratio: Evidence from cotton and soybean markets. The Journal of Business and Economic Studies, 13(1), 38.
- Bollerslev, T. (1986). Generalized autoregressive conditional heteroscedasticity. Journal of Econometrics, 31(3), 307-327.
- Bonga-Bonga, L., & Umoetok, E. (2016). The effectiveness of index futures hedging in emerging markets during the crisis period of 2008-2010: Evidence from South Africa. Applied Economics, 48(42), 3999-4018.
- Brailsford, T. J., & Cusack, A. J. (1997). A comparison of futures pricing models in a new market: The case of individual share futures. Journal of Futures Markets, 17(5), 515-541.
- Brooks, C., & Chong, J. (2001). The cross-currency hedging performance of implied versus statistical forecasting models. Journal of Futures Markets, 21(11), 1043-1069.
- Butterworth, D., & Holmes, P. (2001). The hedging effectiveness of stock index futures: evidence for the FTSE-100 and FTSE-Mid250 indexes traded in the UK. Applied Financial Economics, 11(1), 57-68.
- Castelino, M. G. (1992). Hedge effectiveness: Basis risk and minimum-variance hedging. Journal of Futures Markets, 12(2), 187-201.
- Chan, L. H., & Lien, D. D. (2001). Cash settlement and price discovery in futures markets. 40(3/4), 65-77.
- Chang, J. S. K., & Shanker, L. (1987). A risk-return measure of hedging effectiveness: a comment. Journal of Financial and Quantitative Analysis, 22(3), 373-376.
- Chang, C. –Y., Lai, J. –Y., & Chuang, I. –Y. (2010).Futures hedging effectiveness under the segmentation of bear/bull energy markets. Energy Economics, 32(2), 442-449.
- Chen, S. –Y., Lin, C. –C., Chou, P. –H., & Hwang, D.–Y. (2002). A comparison of hedge effectiveness and price discovery between TAIFEX TAIEX index futures and SGX MSCI Taiwan index futures. Review of Pacific Basin Financial Markets and Policies, 5(2), 277-300.
- Chen, C. –C., & Tsay, W. –J. (2011). A Markov regimeswitching ARMA approach for hedging stock indices.Journal of Futures Markets, 31(2), 165-191.
- Chen, S. –S., Lee, C. –F., & Shrestha, K. (2004). An empirical analysis of the relationship between the hedge ratio and hedging horizon: A simultaneous estimation of the short-and long-run hedge ratios. Journal of Futures Markets, 24(4), 359-386.
- Chen, S. –S., Lee, C. –F., & Shrestha, K. (2001). On a Mean—Generalized Semivariance Approach to Determining the Hedge Ratio. Journal of Futures Markets, 21(6), 581-598.
- Chen, P., Zirong, Z., & Liu, J. (2016). Estimation and Comparative of dynamic optimal hedge ratios of China gold futures based on ECM-GARCH.International Journal of Economics and Finance, 8(3), 236.
- Choudhry, T. (2004). The hedging effectiveness of constant and time-varying hedge ratios using three Pacific Basin stock futures. International Review of Economics and Finance, 13, 371–385.
- Chou, W. L., Denis, K. K. F., & Lee, C. F. (1996). Hedging with the Nikkei index futures: The convential model versus the error correction model. The Quarterly Review of Economics and Finance, 36(4), 495-505.
- Collins, R. A (2000). The risk management effectiveness of multivariate hedging models in the US soy complex.Journal of Futures Markets, 20(2), 189-204.
- Das, J. K., & Chakraborty, G. (2015). The hedging performance of commodity futures in India: An empirical study on some agricultural commodities.International Journal of Information, Business and Management, 7(3), 162.
- Deaves, R. (1994). Naive versus conditional hedging strategies: The case of Canadian stock index futures.Canadian Journal of Administrative Sciences, 11(3), 264-270.
- Dimson, E., & Mussavian, M. (1998). A brief history of market efficiency. European Financial Management, 4(1), 91-103.
- Ederington, L. H. (1979). The hedging performance of the new futures markets. The Journal of Finance, 34(1), 157-170.
- Engle, R. F. (1982). Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation. Econometrica: Journal of the Econometric Society, 987-1007.
- Engle, R. F., & Granger, C. W. J. (1987). Co-integration and error correction: Representation, estimation, and testing. Econometrica: Journal of the Econometric Society, 251-276.
- Figlewski, S. (1984). Hedging performance and basis risk in stock index futures. The Journal of Finance, 39(3), 657-669.
- Floros, C., & Vougas, D. V. (2004). Hedge ratios in Greek stock index futures market. Applied Financial Economics, 14(15) 1125-1136.
- Floros, C., & Vougas, D. (2006). Hedging effectiveness in Greek stock index futures market, 1999-2001.International Research Journal of Finance and Economics, 5, 7-18.
- Ghosh, A. (1993). Cointegration and error correction models: Intertemporal causality between index and futures prices. Journal of Futures Markets, 13, 193-198.
- Gupta, K., & Singh, B. (2009). Estimating the optimal hedge ratio in the Indian Equity Futures market. IUP Journal of Financial Risk Management, 6(3/4), 38.
- Herbst, A. F., McCormack, J. P., & West, E. N. (1987). Investigation of a lead-lag relationship between spot stock indices and their futures contracts. Journal of Futures Markets, 7(4), 373-381.
- Holmes, P. (1995). Ex ante hedge ratios and the hedging effectiveness of the FTSE-100 stock index futures contract. Applied Economics Letters, 2(3), 56-59.
- Hou, Y., & Li, S. (2013). Hedging performance of Chinese stock index futures: An empirical analysis using wavelet analysis and flexible bivariate GARCH approaches. Pacific-Basin Finance Journal, 24, 109-131.
- Howard, C. T., & D’Antonio, L. J. (1984). A risk-return measure of hedging effectiveness. Journal of Financial and Quantitative Analysis, 19(1), 101-112.
- Hsln, C. –W., Kuo, J., & Lee, C. –F. (1994). A new measure to compare the hedging effectiveness of foreign currency futures versus options. Journal of Futures Markets, 14(6), 685-707.
- Johnson, L. L. (1960). The theory of hedging and speculation in commodity futures. The Review of Economic Studies, 27(3), 139-151.
- Karpoff, J. M. (1987). The relation between price changes and trading volume: A survey. Journal of Financial and Quantitative Analysis, 22(1), 109-126.
- Kavussanos, M. G., & Nomikos, N. K. (2000). Constant vs. time-varying hedge ratios and hedging efficiency in the BIFFEX market. Transportation Research Part E: Logistics and Transportation Review, Vol. 36, No.4, pp. 229-248.
- Kenourgios, D., Samitas, D., & Drosos, P. (2008). Hedge ratio estimation and hedging effectiveness: the case of the S&P 500 stock index futures contract.International Journal of Risk assessment and management, 9, 1-2, 121-134.
- El-Khatib, Y., & Hatemi-J, A. (2013). Asymmetric optimal hedge ratio with an application. In Electrical Engineering and Intelligent Systems, pp. 231-237.
- Kofman, P., & McGlenchy, P. (2005). Structurally sound dynamic index futures hedging. Journal of Futures Markets, 25(12), 1173-1202.
- Koutmos, G., & Pericli, A. (1998). Dynamic hedging of paper with T bill futures. Journal of Futures Markets, 18(8), 925-938.
- Kroner, K. F., & Sultan, J. (1993). Time-varying distributions and dynamic hedging with foreign currency futures. Journal of Financial and Quantitative Analysis, 28(4), 535-551.
- Kumar, B., Singh, P., & Pandey, A. (2008). Hedging effectiveness of constant and time varying hedge ratio in Indian stock and commodity futures markets.Available at SSRN 1206555.
- Kumar, B., & Pandey, A. (2013). Market efficiency in Indian commodity futures markets. Journal of Indian Business Research, 5(2), 101-121.
- Lee, H. –T., & Yoder, J. K. (2007). A bivariate Markov regime switching GARCH approach to estimate time varying MVHRs. Applied Economics, 39(10), 1253-1265.
- Lee, H. –C., & Chien, C. –Y. (2010). Hedging performance and stock market liquidity: Evidence from the taiwan futures market. Asia-Pacific Journal of Financial Studies, 39(3), 396-415.
- Lien, D. (2005). A note on the superiority of the OLS hedge ratio. Journal of Futures Markets, 25(11), 1121-1126.
- Lien, D., Tse, Y. K., & Tsui, A. K. C. (2002). Evaluating the hedging performance of the constant-correlation GARCH model. Applied Financial Economics, 12(11), 791-798.
- Lindahl, M. (1991). Risk-return hedging effectiveness measures for stock index futures. Journal of Futures markets, 11(4), 399-409.
- Lypny, G., & Powalla, M. (1998). The hedging effectiveness of DAX futures. The European Journal of Finance, 4(4), 345-355.
- Maharaj, E. A., Moosa, I., Dark, J., & Silvapulle, P.(2008). Wavelet estimation of asymmetric hedge ratios: Does econometric sophistication boost hedging effectiveness? International Journal of Business and Economics, 7(3), 213.
- Malliaris, A. G., & Urrutia, J. L. (1991). The impact of the lengths of estimation periods and hedging horizons on the effectiveness of a hedge: Evidence from foreign currency futures. Journal of Futures Markets, 11(3), 271-289.
- Malhotra, M. (2015). Evaluating the Hedging Performance of Oil and Oilseeds Futures in India. Paradigm, 19(2), 184-196.
- Mandal, A. (2011). Hedging effectiveness of stock index futures contracts in the Indian derivative markets. International Journal of Financial Management, 1(2), 1-20.
- Men, X., & Men, X. (2009). Hedging effectiveness of Hong Kong stock index futures contracts.International Journal of Business and Management, 3(8), 98.
- Moon, G. –H., Yu, W. –C., & Hong, C. –H. (2009).Dynamic hedging performance with the evaluation of multivariate GARCH models: Evidence from KOSTAR index futures. Applied Economics Letters, 16(9), 913-919.
- Moosa, I. (2003). The sensitivity of the optimal hedge ratio to model specification, Finance Letters, Vol. 1, No. 1, pp. 15-20.
- Moschini, G. –C., & Myers, R. J. (2002). Testing for constant hedge ratios in commodity markets: a multivariate GARCH approach. Journal of Empirical Finance, 9(5), 589-603.
- Myers, R. J. (1991). Estimating time-varying optimal hedge ratios on futures markets. Journal of Futures Markets, 11(1), 39-53.
- Nelson, D. B. (1991), Conditional heteroskedasticity in asset returns: A new approach. Econometrica: Journal of the Econometric Society, 347-370.
- Park, T. H., & Switzer, L. N. (1995). Time-varying distributions and the optimal hedge ratios for stock index futures. Applied Financial Economics, 5(3), 131-137.
- Pattarin, F., & Ferretti, R. (2004). The Mib30 index and futures relationship: Econometric analysis and implications for hedging. Applied Financial Economics, 14(18), 1281-1289.
- Pennings, J. M. E., & Meulenberg, M. T. G. (1997). Hedging efficiency: A futures exchange management approach. Journal of Futures Markets, 17(5), 599-615.
- Pradhan, K. (2011). The hedging effectiveness of stock index futures: Evidence for the S&P CNX nifty index traded in India. South East European Journal of Economics and Business, 6(1), 111-123.
- Rao, S. V. D. N., & Thakur, S. K. (2008). Optimal hedge ratio and hedge efficiency: An empirical investigation of hedging in Indian derivatives market. Society of Actuaries, Monograph Publication, pp. 1-27.
- De Salles, A. A. (2013). An investigation of some hedging strategies for crude oil market. International Journal of Energy Economics and Policy, 3(1), 51.
- Srinivasan, P. (2011). Hedging effectiveness of constant and time-varying hedge ratio in Indian commodity futures markets: Evidence from The MultiCommodity Exchange. IUP Journal of Financial Economics, 9(3), 7-27.
- Stein, J. L. (1961). The simultaneous determination of spot and futures prices. The American Economic Review, 51(5), 1012-1025.
- Stoll, H. R., & Whaley, R. E. (1990). The dynamics of stock index and stock index futures returns. Journal of Financial and Quantitative Analysis, 25(4), 441-468.
- Veronesi, P. (1999). Stock market overreactions to bad news in good times: a rational expectations equilibrium model. The Review of Financial Studies, 12(5), 975-1007.
- Wang, Y., Wu, C., & Yang, L. (2015). Hedging with futures: Does anything beat the naïve hedging strategy?. Management Science, 61(12), 2870-2889.
- Working, H. (1953). Futures trading and hedging. American Economic Review, 43, 314-343.
- Yang, M. J., & Lai, Y. C. (2009). An out-of-sample comparative analysis of hedging performance of stock index futures: Dynamic versus static hedging. Applied Financial Economics, 19(13), 1059-1072.
- Yang, W., & Allen, D. E. (2005). Multivariate GARCH hedge ratios and hedging effectiveness in Australian futures markets. Accounting & Finance, 45(2), 301-321.
- Revoredo-Giha, C., & Zuppiroli, M. (2014). Exploring the hedging effectiveness of European wheat futures markets during the 2007-2012 period. Procedia Economics and Finance, 14, 90-99.
Abstract Views: 405
PDF Views: 1