Abstract
This paper examines the role of commodity futures market as an instrument of hedging against price risk. Hedging is the practice of offsetting the price risk in a cash market by taking an opposite position in the futures market. By taking a position in the futures market, which is opposite to the position held in the spot market, the producer can offset the losses in the latter with the gains in the former. Both static and time varying hedge ratios have been calculated using VECM-MGARCH model. Variance of return from hedge portfolio has been found to be low. Further hedging effectiveness has been observed to be around 12%.
Highlights
The financial development of any nation depends on the efficiency and soundness of its exchange markets
Since risk is usually measured as the volatility of portfolio returns, an intuitively possible strategy might be to choose that hedge ratio which minimizes the variance of the returns of a portfolio containing the spot and future position; this is known as the optimal hedge ratio
Both series are used in log form and denoted as “LOG SPOT” and “LOG FUTURE”
Summary
The financial development of any nation depends on the efficiency and soundness of its exchange markets. There is a need for systematic investigation of Indian future market for gold to assess its hedge effectiveness to manage risk element since future markets for gold has not been received sufficient attention on the estimation of hedge ratio and hedge effectiveness. This particular study is an attempt to investigate the hedging effectiveness of gold price in determining spot and future price in a developing country like India and it would help to protect the interest of traders
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