Carry Costs and Futures Hedge Calculations

Advances in Investment Analysis and Portfolio Management, Vol. 6, pp. 1-34, 2014

Fordham University Schools of Business Research Paper No. 2694867

34 Pages Posted: 25 Nov 2015

See all articles by Robert Ferguson

Robert Ferguson

AnswersToGo

Dean Leistikow

Fordham University - Finance Area

Steven B. Raymar

Fordham University - Finance Area

Date Written: March 31, 2014

Abstract

This paper calculates carry costs directly and focuses on the effect that carry cost lumpiness has on hedge variables. It shows that carry cost adjusted price changes should be used to reduce errors in the calculated hedge: ratio, profit, and effectiveness. Results demonstrate that the errors can be both statistically and economically significant and tend to be more significant if the asset’s carry costs are lumpier (that is, larger and less frequent). We study the traditional regression (TR), carry cost adjusted regression (CCAR), and error correction (EC) hedge ratio calculation approaches. Unlike the CCAR method, the TR and EC approaches err by using the spot price change to represent spot profit. When the payout dates are included in the analysis, the CCAR in-sample hedge effectiveness is statistically significantly higher than it is for the TR and EC approaches. Furthermore, when payout dates are excluded, their hedge effectiveness results converge toward those for the CCAR method. The CCAR approach provides out-of-sample hedge effectiveness that is higher than that for either of the other approaches. Additionally, the (in-sample to out-of-sample) hedge effectiveness slippage is about half as much for the TR and CCAR approaches as it is for the EC approach. Finally, though the hedge ratios are similar across methods, the hedge profits of the assets studied are significantly mismeasured because the TR and EC methods ignore carry costs.

Keywords: Futures Hedge Ratio, Hedge Profits, Hedge Effectiveness

Suggested Citation

Ferguson, Robert and Leistikow, Dean and Raymar, Steven B., Carry Costs and Futures Hedge Calculations (March 31, 2014). Advances in Investment Analysis and Portfolio Management, Vol. 6, pp. 1-34, 2014; Fordham University Schools of Business Research Paper No. 2694867. Available at SSRN: https://ssrn.com/abstract=2694867

Robert Ferguson

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6815 Edgewater Drve
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Dean Leistikow (Contact Author)

Fordham University - Finance Area ( email )

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United States

Steven B. Raymar

Fordham University - Finance Area ( email )

33 West 60th Street
New York, NY 10023
United States
212-636-6159 (Phone)
212-765-5573 (Fax)

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