Hedging Effectiveness of Constant and Time Varying Hedge Ratio of the Copper in the London Metal Exchange

Abstract

This paper evaluates different hedging strategies for copper futures contracts traded at the London Metal Exchange. We estimate dynamic and constant hedge ratio for futures contracts. Various models (Minimum variance hedge ratio, OLS regression model, VAR) are used to estimate constant hedge ratio. To estimate dynamic hedge ratio, we use BEKK and VARMGARCH models. This research provides an empirical comparison of different econometric technique in the context of hedging the market risk of copper traded at the London Metal Exchange. It is found that the VARMGARCH model estimates of time varying hedge ratio provide highest variance reduction. Besides, we examine the relation between hedging effectiveness and the maturity of the contract.