The Hedging Performance of the New Futures Markets: Comment

Abstract

IN A RECENT ARTICLE appearing in this Journal, Louis Ederington [2] examines the hedging performance of the futures markets in financial securities by using a basic portfolio model that was previously applied to the analysis of commodities futures markets by Johnson [3] and Stein [4]. A conclusion he reaches is that two week hedges using 90 day Treasury Bill futures are rather ineffective in reducing exposure to price change risk. One purpose of this comment is to show that within the context of Ederington's analysis two week hedges using T-Bill futures are more effective than he found and in fact compare favorably with similar hedges in other markets. One aspect of this type of hedge which is unique to the financial markets is that the maturity of the cash position decreases during the hedge. This comment extends Ederington's work by estimating for the T-Bill market the effects of changing maturity on the variance minimizing hedge ratio. Furthermore, it is shown that the decreasing maturity tends to limit the flexibility of the timing of hedges in financial markets relative to those in commodity markets.