Does Market Volatility Affects Hedge Effectiveness? An Empirical Investigation of Time-Invariant and Time-Varying Hedges During Period of Financial Crisis in Indian Futures Market

33 Pages Posted: 22 Aug 2010

See all articles by S.V.D. Nageswara Rao

S.V.D. Nageswara Rao

Indian Institute of Technology (IIT), Bombay - Shailesh J. Mehta School of Management (SJM)

Sanjay Kumar Thakur

Indian Institute of Technology (IIT), Bombay

Date Written: August 22, 2010

Abstract

Financial derivatives are extensively used as hedging instruments worldwide, including emerging markets like Malaysian, Italian, and Portuguese equity markets. However, hedging one’s stock position through futures is still the road less traveled in India.

This study is, therefore, an attempt to explore Indian futures market for hedging by equity holders in general as well as in period of financial crisis. We have estimated effectiveness of the optimal hedge ratio based on HKM [Herbst, Kare and Marshall (1993)] methodology with benchmark model JSE [Johnson (1960), Stein (1961) and Ederington (1979)] methodology for futures. Hedge ratio based on HKM methodology is a time-variant whereas hedge ratio based on JSE methodology is a constant and time-invariant. To bring the comparison of hedge effectiveness on equal level (from transaction cost point of view), time-varying hedge ratio estimated based on HKM methodology “time-invariant” and then Bases using the hedge ratios are estimated.

For empirical validation of the Effectiveness of the optimal hedge ratios and their stability in normal as well in the period of financial crisis, the study of S&P Nifty Index {National Stock Exchange of India (NSE) – 50 Index and its futures is conducted using daily data for the year 2005 (representing normal period) and January 2007 to June 2009 (representing turbulent time period) based on the value of volatility index.

Results suggest that hedge using HKM model is more effective than that of hedge based on JSE model. The results are statistically significant at 95% confidence level. An additional contribution of this study is to help the hedger to decide “when” to re-balance the hedge.

Keywords: Hedging, Market Risk, Capital Market, Futures Market, Regression, Time-Varying Hedging Models

Suggested Citation

Nageswara Rao, S. V. D. and Thakur, Sanjay Kumar, Does Market Volatility Affects Hedge Effectiveness? An Empirical Investigation of Time-Invariant and Time-Varying Hedges During Period of Financial Crisis in Indian Futures Market (August 22, 2010). Available at SSRN: https://ssrn.com/abstract=1663373 or http://dx.doi.org/10.2139/ssrn.1663373

S. V. D. Nageswara Rao

Indian Institute of Technology (IIT), Bombay - Shailesh J. Mehta School of Management (SJM) ( email )

Powai
Mumbai 400076
India
91-22-25767789 (Phone)
91-22-25722872 (Fax)

Sanjay Kumar Thakur (Contact Author)

Indian Institute of Technology (IIT), Bombay ( email )

Powai
IIT Bombay, Powai
Mumbai, Maharashtra 400076
India
91-22-25764785 (Phone)

HOME PAGE: http://www.som.iitb.ac.in/homepage/~sanjaykumar/

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
267
Abstract Views
1,839
Rank
216,769
PlumX Metrics