Measuring minimum variance hedging effectiveness: Traditional vs. sophisticated models

This study investigates whether the more sophisticated GARCH based models are better minimum variance hedging strategies than the less sophisticated regression based traditional models. The findings of the study suggest that the traditional models that directly estimate the optimal hedge ratio significantly outperform the more sophisticated models that indirectly estimate the optimal hedge ratio based on timevarying variance-covariance parameters. Although, the sophisticated models seem to have more theoretical appeal, the higher estimation and misspecification errors of these models reduce their hedging effectiveness, making them inferior to the traditional models.