Return distribution, leverage effect and spot-futures spread on the hedging effectiveness

• Published in: Finance research letters Vol. 22; pp. 158 - 162
• Main Authors: Kao, Wei-Shun, Lin, Chu-Hsiung, Changchien, Chang-Cheng, Wu, Chien-Hui
• Format: Journal Article
• Language: English
• Published: Elsevier Inc 01.08.2017
• Subjects: Optimal hedge ratio; Skewed generalized t distribution; Spread; Volatility; Skewed generalized t distribution; G12; Optimal hedge ratio; Spread; Volatility
• ISSN: 1544-6123; 1544-6131
• DOI: 10.1016/j.frl.2016.12.036

•This paper proposes a revised GJR model for estimating hedge ratios.•The proposed model takes into account leverage effect, fat-tailed distribution, and spot-futures spread in the return behavior.•Hedge performance in terms of the White's (2000) reality check is conducted.•The optimal hedge model is the GARCH model with the asymmetric spread based on the fat-tailed distribution for longer horizons. This paper proposes a revised Glosten-Jagnnathan-Runkle (GJR) model for estimating hedge ratios. The model can take into account three important characteristics in the return behavior, i.e., fat-tailed distribution, leverage effect, and spot-futures spread. Hedge performance in terms of the White's (2000) reality check is conducted. Our results demonstrate that the generalized autoregressive conditional heteroskedasticity (GARCH) model that considers both fat-tailed distribution and asymmetric effects of the spread provides the best hedging effectiveness for longer horizons.