The Effect of Asymmetries on Optimal Hedge Ratios

Abstract

There is widespread evidence that the volatility of stock returns displays an asymmetric response to good and bad news. This article considers the impact of asymmetry on time-varying hedges for financial futures. An asymmetric model that allows forecasts of cash and futures return volatility to respond differently to positive and negative return innovations gives super in-sample hedging performance. However, the simpler symmetric model is not inferior in a hold-out sample. A method for evaluating the models in a modern risk-management framework is presented, highlighting the importance of allowing the optimal hedge ratios to be both time-varying and asymmetric.