HEDGE RATIOS

Stability and Effectiveness of Hedge Ratios in Volatile Index Futures Markets: Hong Kong and Korean Markets

Table of Contents

CHAPTER NO 1: INTRODUCTION3

Statement of the Problem3

Significance of the Problem3

Objective of Study4

CHAPTER NO 2: LITERATURE REVIEW5

CHAPTER NO 3: RESEARCH DESIGN AND METHODOLOGY7

CHAPTER NO 1: INTRODUCTION

Statement of the Problem

The stability and effectiveness of hedge ratios in volatile index futures markets has been investigated by various past studies through the minimum variance hedge ratio that is MVHR. This research examines two of the most heavily traded stock index futures contracts in Asia that are the South Korean composite stock index 200 futures that is KOSPI 200 and the Hang Seng index futures. Past researches used the OLS regression to find the estimation of hedge ratios. The key concern with the estimates of OLS regression over long-term time period is that the hidden assumption that the slope of regression will remain stable over the time period. An unstable minimum variance hedge ratio over the time period will results in a seriously biased hedge ratio to the effectiveness hedging and also the effectiveness of estimate measures. For that reason, it is important for the hedgers to validate the stability of minimum variance hedge ratio.

Significance of the Problem

Past researches show that the hedge ratios which are generated from the historical data through the OLS regression might fluctuate from period to period. In addition to this, it was also found that futures volatility in hedge ratios follows random walk for equities and currencies. Particularly, the hedge ratio stability which is an assumption seems to be problematic given the extensive exchange rate turbulence and volatility. It is observed that the variances in the daily returns during the financial crisis were larger than those in the period before the crisis for most stock markets.

Objective of Study

This research finds markedly higher volatilities in the stock prices for the stock markets for Korean and also the Hong Kong in the Asian financial crisis and after the period of crisis than in the before the period of crisis. For that reason, the key objective of this research is to inspect the concern of whether the hedge ratios are effective and stable for the Asian financial crisis and after the period of crisis which is based on the volatility of high prices. The instability of hedge ratios proposes a strategy of time varying hedging that entails estimating the volatility in hedge ratios for a portfolio that allows variation of time in the matrix of variance-covariance of futures and spot returns. Therefore, if the hedge ratios are not stable over the time, a relationship of the stability and effectiveness of hedging will present the superiority of time varying hedge ratios over the constant ratios. This examination estimates the time varying hedge ratios through the bivariate error correction generalized auto-regressive conditional hetero-skedastic that is the GARCH model. The quickly growing Asian economies persist to create a center of attention of the fund managers who are international and seek opportunities to enhance the performance of ...