Futures Hedge Profit Measurement Error-Correction Model vs. Regression Approach Hedge Ratios, and Data Error Effects
Financial Management, Vol. 28, No. 4, Winter 1999
10 Pages Posted: 24 Jun 2017
Date Written: January 15, 1999
This paper proposes that, and explains why, hedge profits and regression approach hedge ratios should be calculated using cost-of-carry-adjusted price changes. This Modified Regression Method for determining hedge ratios is denoted MRM. The paper discusses the Error-Correction Model for hedge ratio determination as it has been applied (denoted ECM), discusses how it should be applied, and relates each to the MRM. Data errors can cause the MRM hedge ratios to be smaller and more variable than the ECM's (as observed empirically). On theoretical and practical grounds, the MRM is preferred to the ECM unless there are significant data errors.
Keywords: futures, hedge ratio, error-correction, data error effects, hedge ratio estimation
JEL Classification: G10, G13
Suggested Citation: Suggested Citation