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

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  • Enrique Salvador
  • Vicent Aragó

Abstract

This study estimates linear and nonlinear GARCH models to find optimal hedge ratios with futures contracts for some of the main European stock indexes. By introducing nonlinearities through a regime‐switching model, we can obtain more efficient hedge ratios and superior hedging performance in both an in‐sample and an out‐sample analysis compared to the other methodologies (constant hedge ratios and linear GARCH). Moreover, nonlinear models also reflect the different patterns followed by the dynamic relationship between the volatility of spot and futures returns during low‐ and high‐volatility periods. © 2013 Wiley Periodicals, Inc. Jrl Fut Mark 34:374–398, 2014

Suggested Citation

  • Enrique Salvador & Vicent Aragó, 2014. "Measuring Hedging Effectiveness of Index Futures Contracts: Do Dynamic Models Outperform Static Models? A Regime‐Switching Approach," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 34(4), pages 374-398, April.
    • Handle: RePEc:wly:jfutmk:v:34:y:2014:i:4:p:374-398
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    1. Urom, Christian & Onwuka, Kevin O. & Uma, Kalu E. & Yuni, Denis N., 2020. "Regime dependent effects and cyclical volatility spillover between crude oil price movements and stock returns," International Economics, Elsevier, vol. 161(C), pages 10-29.
    2. Philip, Dennis & Shi, Yukun, 2016. "Optimal hedging in carbon emission markets using Markov regime switching models," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 43(C), pages 1-15.
    3. Chun, Dohyun & Cho, Hoon & Kim, Jihun, 2019. "Crude oil price shocks and hedging performance: A comparison of volatility models," Energy Economics, Elsevier, vol. 81(C), pages 1132-1147.
    4. Stavros Degiannakis & Christos Floros & Enrique Salvador & Dimitrios Vougas, 2022. "On the stationarity of futures hedge ratios," Operational Research, Springer, vol. 22(3), pages 2281-2303, July.
    5. Park, Jin Suk & Shi, Yukun, 2017. "Hedging and speculative pressures and the transition of the spot-futures relationship in energy and metal markets," International Review of Financial Analysis, Elsevier, vol. 54(C), pages 176-191.
    6. Pan, Zhiyuan & Xiao, Dongli & Dong, Qingma & Liu, Li, 2022. "Structural breaks, macroeconomic fundamentals and cross hedge ratio," Finance Research Letters, Elsevier, vol. 47(PA).

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