M-Garch Hedge Ratios and Hedging Effectiveness in Australian Futures Markets

Abstract

This study estimates optimal hedge ratios using various econometric models. Using both All Ordinary Index and SPI futures on the Australian market, the optimal hedge ratios are calculated from the OLS regression model, the bivariate vector autoregressive model (BVAR), the error-correction model (ECM) and the multivariate diagonal Vec GARCH Model. The hedging effectiveness is measured in terms of ex-post and ex-ante risk-return trade-off at various forecasting horizons. It is generally found that the GARCH time varying hedge ratios provide the greatest portfolio risk reduction, particularly for longer hedging horizons, but they do not generate the highest portfolio return.

Keywords: OLS method, VAR model, error correction term, M-GARCH modelling

JEL Classification: C5, G1, N2