Measuring minimum variance hedging effectiveness: Traditional vs. sophisticated models

Sharma, Udayan; Karmakar, Madhusudan

doi:10.1016/j.irfa.2023.102621

Cited by 4 publications

(5 citation statements)

References 51 publications

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“…However, the calculated hedge ratios for the two conventional models, OLS and ECM, are very close to each other in all the pairs of hedged instruments used in the study. This is not surprising, given that they share model static regression model fundamentals, our previous findings in the case of single hedging strategies and the empirical results of other studies in the literature [26,72]. Moreover, the results show that the average hedge ratios generated from the conventional methods (OLS and ECM) compared to more sophisticated models (ADCC and t-copula), indeed, differ.…”

Section: Composite Hedging Strategy Performancesupporting

confidence: 73%

“…Therefore, it aims to hedge against a possible rise in the price of CO 2 by using futures contracts, which are highly correlated with the spot market. A common approach to hedging strategies is based on the minimum-variance hedge ratio, i.e., the hedge ratio that minimizes the variance of the hedged portfolio [26,[70][71][72]. In this context, the shipping company decides on the optimal number of futures contracts that minimize the risk of the combined portfolio of the CO 2 spot and futures.…”

Section: Methodsmentioning

confidence: 99%

“…The Error Correction (ECM) model is used in response to the downsides of using the OLS hedge ratio that ignores short-run dynamics and the cointegrating relationship between spot and futures prices. The empirical literature advocates that the ECM model is a better alternative to the classical OLS model and may lead to the estimation of more accurate hedge ratios [70,72,82]. The ECM model can be defined as:…”

Section: Error Correction Model (Ecm)mentioning

confidence: 99%

“…The GARCH-type strategies, as represented by the ADCC and t-copula models, produce higher variance than the OLS and ECM strategies. As noted in the literature, some of the potential explanations for the low hedging effectiveness of the GARCH-type models are [70,72,93]: (i) they have more parameters to estimate and hence higher estimation errors than other models; (ii) model misspecification could also be a potential factor that makes the GARCH-type models perform worse than other models the more parameters; (iii) Allowing for time variation across the variance-covariance matrix of returns, the dynamic models seems to induce greater variance while forming hedged portfolios, and the OHR are more sensitive to the size and sign of the change in prices. It is obvious that the OLS model is more stable and not as volatile as its dynamic counterparts, which is especially useful in hedging strategies where there is a strong correlation between spot and future prices.…”

Section: Single Hedging Strategy Performancementioning

confidence: 99%

See 3 more Smart Citations

Hedging Strategies in Carbon Emission Price Dynamics: Implications for Shipping Markets

Syriopoulos,

Roumpis,

Tsatsaronis

2023

Energies

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The European Union (EU) has agreed to gradually include shipping in the EU emissions trading scheme (EU ETS), which makes shipping companies vulnerable to carbon price fluctuations. The aim of this paper is to investigate the effectiveness of carbon and petroleum futures contracts in managing carbon and bunker risks. We examine the effectiveness of alternative hedging methods, including both static and dynamic approaches, to estimate optimal hedge ratios under single and composite cross-hedge settings. Our results show that carbon future contracts are important for hedging the carbon emission allowances price risk, and Brent oil futures are the most effective instrument for out-of-sample hedging of bunker prices. In addition, the hedging effectiveness indicates that conventional methods outperform the sophisticated models in terms of variance reduction. Our study offers new insights into how the carbon and bunker markets relate to a combination hedging in reducing the joint price risk, which can be used to promote risk management in the market.

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Section: Composite Hedging Strategy Performancesupporting

confidence: 73%

Section: Methodsmentioning

confidence: 99%

Section: Error Correction Model (Ecm)mentioning

confidence: 99%

Section: Single Hedging Strategy Performancementioning

confidence: 99%

See 2 more Smart Citations

Hedging Strategies in Carbon Emission Price Dynamics: Implications for Shipping Markets

Syriopoulos,

Roumpis,

Tsatsaronis

2023

Energies

View full text Add to dashboard Cite

show abstract

“…The sophisticated models tend to stop performing well when a relatively small change is made in its specification, making the hedging effectiveness is sensitive to model specification (Sharma & Karmakar, 2023).…”

Section: Discussionmentioning

confidence: 99%

The effectiveness of crude oil futures hedging during infectious disease outbreaks in the 21st century

Teo

Chan

2023

Journal of Futures Markets

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This study analyzes the hedging effectiveness of crude oil futures during infectious disease outbreaks in the 21st century. The conditional volatility of crude oil markets experienced a greater shock during the coronavirus disease 2019 (COVID‐19) pandemic than during the severe acute respiratory syndrome and swine‐origin influenza A outbreaks. The sharp decline in the conditional correlation of crude oil markets following the onset of COVID‐19 increases the persistence of shocks to correlations, thereby diminishing the effectiveness of futures contracts as a hedging instrument.

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Asymptotic Dependence and Its Impact on Hedging Effectiveness: An Examination of Stock, Currency, and Commodity Futures

Sharma,

Karmakar

2024

Journal of Futures Markets

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This study measures the asymptotic dependence between spot and futures losses and investigates its impact on hedging effectiveness using data from stock, currency, and commodity markets. The findings reveal that stock futures contracts show strong asymptotic dependence, while currency futures have weak asymptotic dependence and most commodity futures lack asymptotic dependence with the underlying spots. Further, stock futures have the highest hedging effectiveness, while commodity and currency futures show low hedging effectiveness for downside risk. Results also suggest that asymptotic dependence is critical for minimum‐variance hedging. Asymptotic dependence increases with the hedging horizon, leading to a better hedging performance of the futures. It also appears that the hedging strategies sensitive to asymptotic dependence perform better than the competing models. The results for the entire period and the subsample periods offer similar conclusions.

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Measuring minimum variance hedging effectiveness: Traditional vs. sophisticated models

Cited by 4 publications

References 51 publications

Hedging Strategies in Carbon Emission Price Dynamics: Implications for Shipping Markets

Hedging Strategies in Carbon Emission Price Dynamics: Implications for Shipping Markets

The effectiveness of crude oil futures hedging during infectious disease outbreaks in the 21st century

Asymptotic Dependence and Its Impact on Hedging Effectiveness: An Examination of Stock, Currency, and Commodity Futures

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