The Hedging Effectiveness and the Stability of the Optimal Hedge Ratios: Evidence for the Istanbul Stock Exchange 30 Contract

Abstract

In this paper we investigate ex ante hedging effectiveness of the Istanbul Stock Exchange 30 (ISE 30) stock index futures contract covering the period January 2007-December 2014. An optimal hedge ratio is typically calculated by regressing historical spot prices, spot price changes or spot returns on futures prices, futures price changes or returns. The slope of the regression is then used as the optimal hedge ratio. However, no guidelines are provided on what return interval and estimation period should be chosen for the calculation of returns. The empirical research has shown that hedge ratio estimates are not invariant to the return measurement interval or the estimation period. This study finds that although the daily returns for the estimation of hedge ratio provides the best ex-post performance, ex-ante tests favor hedge ratios calculated with longer return intervals and estimation periods. While one should expect greater precision for longer estimation periods, results of this study do not provide satisfactory evidence in favor of this argument.