Constant versus Time Varying Hedge Ratios and Hedging Efficiency in the Biffex Market

Transportation Research Part E (the Logistics and Transportation Review), December 2000, Vol. 36, No 4, Pp. 229-248,

Posted: 18 Feb 2014

See all articles by Nikos K. Nomikos

Nikos K. Nomikos

Cass Business School, City University London

Manolis G. Kavussanos

Athens University of Economics and Business - Department of Accounting and Finance

Date Written: Deceber 2000

Abstract

This paper estimates time-varying and constant hedge ratios, and investigates their performance in reducing freight rate risk in routes 1 and 1A of the Baltic Freight Index. Time-varying hedge ratios are generated by a bivariate error correction model with a GARCH error structure. We also introduce an augmented GARCH (GARCH-X) model where the error correction term enters in the specification of the conditional covariance matrix. This specification links the concept of disequilibrium (as proxied by the magnitude of the error correction term) with that of uncertainty (as reflected in the time varying second moments of spot and futures prices). In- and out-of-sample tests reveal that the GARCH-X specification provides greater risk reduction than a simple GARCH and a constant hedge ratio. However, it fails to eliminate the riskiness of the spot position to the extent evidenced in other markets in the literature. This is thought to be the result of the heterogeneous composition of the underlying index. It seems that restructuring the composition of the Baltic Freight Index (BFI) so as to reflect homogeneous shipping routes may increase the hedging e€ffectiveness of the futures contract. This by itself indicates that the imminent introduction of the Baltic Panamax Index (BPI) as the underlying asset of the Baltic International Financial Futures Exchange (BIFFEX) contract is likely to have a beneficial impact on the market.

Suggested Citation

Nomikos, Nikos K. and Kavussanos, Manolis G., Constant versus Time Varying Hedge Ratios and Hedging Efficiency in the Biffex Market (Deceber 2000). Transportation Research Part E (the Logistics and Transportation Review), December 2000, Vol. 36, No 4, Pp. 229-248,. Available at SSRN: https://ssrn.com/abstract=1435287

Nikos K. Nomikos

Cass Business School, City University London ( email )

London, EC2Y 8HB
Great Britain

Manolis G. Kavussanos (Contact Author)

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission St
TK 104 34 Athens
Greece
0030 210 8203167 (Phone)
0030 210 8228816 (Fax)

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