Abstract
Abstract This paper investigates the hedging effectiveness of the International Index Futures Markets using daily settlement prices for the period 4 January 2010 to 31 December 2015. Standard OLS regressions, Error Correction Model (ECM), as well as Autoregressive Distributed Lag (ARDL) cointegration model are employed to estimate corresponding hedge ratios that can be employed in risk management. The analyzed sample consists of daily closing market rates of the stock market indexes of the USA and the European futures contracts. The findings indicate that the time varying hedge ratios, if estimated through the ARDL model, are more efficient than the fixed hedge ratios in terms of minimizing the risk. Additionally, there is evidence that the comparative advantage of advanced econometric approaches compared to conventional models is enhanced further for capital markets within peripheral EU countries
Highlights
Financial markets have been highly volatile and highly complex in recent decades
We note that the hedge ratio is lower than the unit for all markets except for the DAX index, which is close to 1
The hedge ratio in all methods is similar except Greece's index showing some variations
Summary
Financial markets have been highly volatile and highly complex in recent decades. The determination of optimal hedge ratios has emerged as the main subject of discussion for the academic community, and the subject of monitoring by the majority of financial institutions, investors and businesses. The problem that arises relates to the number of futures that the investor could hold for each underlying unit in order to protect its portfolio against any undesirable market movements. The main objective of the paper is the direct comparison, through a trading strategy process, of the forecasting ability of several econometric approaches that account for the hedging effectiveness. Hedging through trading futures is a common process which is used to control or even reduce the risk of adverse price movements. According to Pennings and Meulenberg (1997), a decisive factor in explaining the success of futures contracts is their hedging effectiveness
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