Abstract
In this paper, we investigate both constant and time-varying hedge ratios in terms of the effectiveness of CSI300 index futures during the COVID-19 crisis. Using naïve, OLS and EC/ROLS strategies to estimate constant hedge ratios, results indicate that the CSI300 spot index presents decreased effectiveness using the naïve hedging strategy; however, increased effectiveness of OLS and EC hedge ratios are identified. Differential behaviour is identified when considering five newly introduced COVID-19 concept-based stock indices. Time-varying hedge ratios indicate the weakened effectiveness, ranging between 20% and 40% variance reduction. Evidence suggests that the capability of the CSI300 index futures to hedge against the risks of the COVID-19 is impaired, regardless of whether constant or time-varying hedge ratios are used. Such results provide important implications to both local and foreign investors in the Chinese stock market.
Highlights
The COVID-19 pandemic has generated interesting questions surrounding whether stock index futures contracts can deliver effective hedging functionality against pandemic-related risks, in China due to early origin effects
Concerning constant cross-hedging within the COVID-19 concept-based stock indices, variance reduction falls from approximately 49% to 61% in the pre-COVID-19 period to a range between 11% and 45% as the COVID-19 pandemic begins
In the P2 period, we find that the CSI300 index futures fail to provide an effective cross-hedging function to the facemask and coronavirus detection indices, due to the negative variance reduction given by the constant conditional correlation (CCC)- and dynamic conditional correlation (DCC)-hedge ratios for the facemask index and the DCC hedge ratio for the coronavirus detection index
Summary
The COVID-19 pandemic has generated interesting questions surrounding whether stock index futures contracts can deliver effective hedging functionality against pandemic-related risks, in China due to early origin effects. Answering this question is important as was China the earliest epicentre of the COVID-19 pandemic, leading to long-range social and economic impacts on the local ecosystem, and a substantial influence upon the pricing dynamics of domestic equity, energy, and commodity markets in both the short- and long-term (Corbet, Hou, Hu, and Oxley, 2020). We consider how the index futures perform in both direct and cross-hedging scenarios during the COVID-19 pandemic
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