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The Limits to Minimum‐Variance Hedging

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  • Richard D. F. Harris
  • Jian Shen
  • Evarist Stoja

Abstract

In this paper, we compare the estimated minimum‐variance hedge ratios from a range of conditional hedging models with the ‘realized’ minimum variance hedge ratio constructed using intraday data. We show that the reduction in conditionally hedged portfolio variance falls far short of the ex post maximal reduction in variance obtained using the realized minimum variance hedge ratio. While this is partly due to systematic bias, correcting for this bias does little to improve hedging effectiveness. The poor performance of conditional hedging models is therefore more likely to be attributable to the unpredictability of the integrated hedge ratio.

Suggested Citation

  • Richard D. F. Harris & Jian Shen & Evarist Stoja, 2010. "The Limits to Minimum‐Variance Hedging," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 37(5‐6), pages 737-761, June.
  • Handle: RePEc:bla:jbfnac:v:37:y:2010:i:5-6:p:737-761
    DOI: 10.1111/j.1468-5957.2009.02170.x
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    Cited by:

    1. Consuela-Elena Popescu & Georgiana Vrinceanu & Alexandra Horobet & Lucian Belascu, 2020. "Managing Exchange Rate Risk with Derivatives: An Application of the Hedge Ratio," Business & Management Compass, University of Economics Varna, issue 3, pages 316-327.
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    3. Stoja, Evarist & Polanski, Arnold & Nguyen, Linh H. & Pereverzin, Aleksandr, 2023. "Does systematic tail risk matter?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 82(C).
    4. Chen, Ren-Raw & Leistikow, Dean & Wang, Andrew, 2020. "Futures minimum variance hedge ratio determination: An ex-ante analysis," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).

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