Multivariate GARCH hedge ratios and hedging effectiveness in Australian futures markets

Authors: Yang, Wenling¹; Allen, David E.²

Source: Accounting and Finance, Volume 45, Number 2, July 2005 , pp. 301-321(21)

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Abstract:

We use the All Ordinaries Index and the corresponding Share Price Index futures contract written against the All Ordinaries Index to estimate optimal hedge ratios, adopting several specifications: an ordinary least squares-based model, a vector autoregression, a vector error-correction model and a diagonal-vec multivariate generalized autoregressive conditional heteroscedasticity model. Hedging effectiveness is measured using a risk-return comparison and a utility maximization method. We find that time-varying generalized autoregressive conditional heteroscedasticity hedge ratios perform better than constant hedge ratios in terms of minimizing risks, but when return effects are also considered, the utility-based measure prefers the ordinary least squares method in the in-sample hedge, whilst both approaches favour the conditional time-varying multivariate generalized autoregressive conditional heteroscedasticity hedge ratio estimates in out-of-sample analyses.

Keywords: Hedge ratio; Cointegration; GARCH; G15; C51; C52

Document Type: Research article

DOI: http://dx.doi.org/10.1111/j.1467-629x.2004.00119.x

Affiliations: 1: Faculty of Economics and Commerce, The University of Western Australia, Crawley, 6009, Australia 2: School of Accounting, Finance and Economics, Edith Cowan University, Joondalup, 6027, Australia

Publication date: 2005-07-01