A statistical model for the relationship between futures contract hedging effectiveness and investment horizon length

Effective Basemetal Hedging: The Optimal Hedge Ratio and Hedging Horizon

“…Before estimating this model, it needs to be addressed how the optimal hedge ratio will be estimated for the different hedging horizons. These estimation techniques are produced in the studies by Geppert (1995) andCLS (2004). Both studies prove that the price changes (∆P t and ∆F t ) in equation (4) should be k-period differenced to properly estimate a respective k-period hedging horizon optimal hedge ratio.…”

“…These findings were later augmented by Geppert (1995), who establishes that hedging effectiveness and the optimal hedge ratio both depend on the permanent and transitory components of the price changes between spot and futures prices. "Over long horizons, the shared component ties the spot and futures series together and the two prices will be perfectly correlated" (Geppert (1995)). A major weakness in the Geppert study is the model requirement that both spot and futures prices be I(1) to implement the Stock and Watson (1988) methodology suggested in the study.…”

“…For the current study, it is important to recall two areas of the literature. First, one branch of the literature aims to justify the use of hedging by procurement divisions (Froot et al (1993), Hansen and Nohria (2004), Koppenhaver and Swidler (1996)), while the second helps determine how best to select optimal futures positions that minimize the risk inherent in the spot (cash) market (chronologically, Fletcher and Ward (1971), Benninga et al (1984), Perron (1989), Baillie and Meyers (1990), Chowdhury (1991), Lien and Luo (1993), Geppert (1995), Alexander (1999, Chen, Lee and Shrestha (2004)). This study is an investigation into the optimal hedge ratio and hedging effectiveness for base metals.…”

Hedging: Scaling and the Investor Horizon

“…However, a number of papers have examined hedging for different time horizons (see Malliaris and Urrutia (1991), Geppert (1995), Chen, Lee and Shrestha (2004) and In and Kim (2006)), and the findings show that as the hedging horizon increases, both the OHR and the insample hedging effectiveness increase. There are contrasting findings out-of-sample 4 See Hwang and Valls Pereira (2006) for a discussion.…”

An Empirical Analysis of Dynamic Multiscale Hedging Using Wavelet Decomposition

“…In the context of hedging, a limited number of studies, including Ederington (1979); Hill and Schneeweis (1982); Malliaris and Urrutia (1991);Benet (1992); Geppert (1995), have demonstrated an increase in hedging effectiveness for longer horizons, by matching the frequency of the data with the hedging horizon. However, out-of-sample, Malliaris and Urrutia (1991); Benet (1992) found a lack of stability in the hedging effectiveness for longer horizons.…”