Hedging Strategies with the KTB Futures

Abstract

This study explores hedging strategies that use the KTB futures to hedge the price risk of the KTB spot portfolio. The study establishes the price sensitivity, risk-minimization, bivariate GARCH (1,1) models as hedging models, and analyzes their hedging performances. The sample period covers from September 29, 1999 to September 18, 2001. Time-matched prices at 11:00 (11:30) of the KTB futures and spot were used in the analysis. The most important findings may be summarized as follows. First, while the average hedge ration of the price sensitivity model is close to one, both the risk-minimization and GARCH model exhibit hedge ratios that are substantially lower than one. Hedge ratios tend to be greater for daily data than for weekly data. Second, for the daily in-sample data, hedging effectiveness is the highest for the GARCH model with time-varying hedge ratios, but the risk-minimization model with constant hedge ratios is not far behind the GARCH model in its hedging performance. In the case of out-of-sample hedging effectiveness, the GARCH model is the best for the KTB spot portfolio, and the risk-minimization model is the best for the corporate bond portfolio. Third, for daily data, the in-sample hedge shows a better performance than the out-of-sample hedge, except for the risk-minimization hedge against the corporate bond portfolio. Fourth, for the weekly in-sample hedges, the price sensitivity model is the worst and the risk-minimization model is the best in hedging the KTB spot portfolio. While the GARCH model is the best against the KTB +corporate bond portfolio, the risk-minimization model is generally as good as the GARCH model. The risk-minimization model performs the best for the weekly out-of-sample data, and the out-of-sample hedges are better than the in-sample hedges. Fifth, while the hedging performance of the risk-minimization model with daily moving window seems somewhat superior to the traditional risk-minimization model when the trading volume increased one year after the inception of the KTB futures, on the average the traditional model is better than the moving-window model. For weekly data, the traditional model exhibits a better performance. Overall, in the Korean bond markets, investors are encouraged to use the simple risk-minimization model to hedge the price risk of the KTB spot and corporate bond portfolios.