Measuring the Hedging Effectiveness of Index Futures Contracts: Do Dynamic Models Outperform Static Models? A Regime-Switching Approach

Posted: 26 May 2011

See all articles by Enrique Salvador

Enrique Salvador

Universitat Jaume I - Department of Finance and Accounting

Vicent Aragó

Jaume I University - Department of Finance and Accounting

Date Written: May 24, 2011

Abstract

This paper estimates linear and non-linear GARCH models to find optimal hedge ratios with futures contracts for some of the main European stock indexes. By introducing non-linearities through a regime-switching model, we can obtain more efficient hedge ratios and superior hedging performance in both in- and out-sample analysis compared with other methods (constant hedge ratios and linear GARCH). Moreover, the non-linear models also reflect different patterns followed by the dynamic relationship between the volatility of spot and futures returns during low and high volatility periods.

Keywords: Futures indices, Dynamic hedging, Hedging Effectiveness, Markov Regime Switching, Asymmetric volatility, Non-linear GARCH

JEL Classification: C13, G11

Suggested Citation

Salvador, Enrique and Aragó, Vicent, Measuring the Hedging Effectiveness of Index Futures Contracts: Do Dynamic Models Outperform Static Models? A Regime-Switching Approach (May 24, 2011). Available at SSRN: https://ssrn.com/abstract=1851713 or http://dx.doi.org/10.2139/ssrn.1851713

Enrique Salvador (Contact Author)

Universitat Jaume I - Department of Finance and Accounting ( email )

Castellon
E-12071 Castello de la Plana, Castellón de la Plana 12071
Spain

Vicent Aragó

Jaume I University - Department of Finance and Accounting ( email )

Avda Sos Baynat s/N
Castellón, 12071
Spain

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