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Optimal hedging under departures from the cost-of-carry valuation: evidence from the Spanish stock index futures market

Novales Cinca, Alfonso and Lafuente Luengo, Juan Ángel (2002) Optimal hedging under departures from the cost-of-carry valuation: evidence from the Spanish stock index futures market. [Working Paper or Technical Report]

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Abstract

We provide an analytical discussion of the optimal hedge ratio under
discrepancies between the futures market price and its theoretical
valuation according to the cost-of-carry model. Assuming a geometric
Brownian motion for spot prices, we model mispricing as a speci…c
noise component in the dynamics of futures market prices. Empirical
evidence on the model is provided for the Spanish stock index
futures. Ex-ante simulations with actual data reveal that hedge ratios
that take into account the estimated, time-varying, correlation
between the common and speci…c disturbances, lead to using a lower
number of futures contracts than under a systematic unit ratio, without
generally losing hedging e¤ectiveness, while reducing transaction
costs and capital requirements. Besides, the reduction in the number
of contracts can be substantial over some periods. Finally, a meanvariance
expected utility function suggests that the economic bene…ts
from an optimal hedge are substantial.

Item Type:Working Paper or Technical Report
Additional Information:JEL classi…cation: C51, G11, G13.
Uncontrolled Keywords:Optimal hedging, Futures contract, Stock Index, GARCH models, Mispricing
Subjects:Social sciences > Economics > Stock exchanges
Series Name:Documentos de trabajo del Instituto Complutense de Análisis Económico (ICAE)
Volume:2002
Number:0223
ID Code:7682
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Deposited On:04 Mar 2008
Last Modified:06 Feb 2014 07:55

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