Cross Hedging with Single Stock Futures

32 Pages Posted: 4 Nov 2004

See all articles by Chris Brooks

Chris Brooks

University of Bristol - School of Economics, Finance and Management

Ryan J. Davies

Babson College - Finance Division

Sang Soo Kim

The Korea Development Bank

Multiple version iconThere are 2 versions of this paper

Date Written: July 1, 2006

Abstract

This study evaluates the efficiency of cross hedging with single stock futures (SSF) contracts. We propose a new technique for hedging exposure to an individual stock that does not have options or exchange-traded SSF contracts written on it. Our method selects as a hedging instrument a portfolio of SSF contracts which are selected based on how closely matched their underlying firm characteristics are with the characteristics of the individual stock we are attempting to hedge. We investigate whether using cross-sectional characteristics to construct our hedge can provide hedging efficiency gains over that of constructing the hedge based on return correlations alone. Overall, we find that the best hedging performance is achieved through a portfolio that is hedged with market index futures and a SSF matched by both historical return correlation and cross-sectional matching characteristics. We also find it preferable to retain the chosen SSF contracts for the whole out-of-sample period while re-estimating the optimal hedge ratio at each rolling window.

Keywords: Basis risk, single stock futures, hedging, universal stock futures

JEL Classification: G1

Suggested Citation

Brooks, Chris and Davies, Ryan J. and Kim, Sang Soo, Cross Hedging with Single Stock Futures (July 1, 2006). Available at SSRN: https://ssrn.com/abstract=614004 or http://dx.doi.org/10.2139/ssrn.614004

Chris Brooks

University of Bristol - School of Economics, Finance and Management ( email )

School of Accounting and Finance
15-19 Tyndalls Park Road
Bristol, BS8 1PQ
United Kingdom

Ryan J. Davies (Contact Author)

Babson College - Finance Division ( email )

220 Tomasso Hall
Babson Park, MA 02457-0310
United States
781-239-5345 (Phone)
781-239-5004 (Fax)

HOME PAGE: http://www.ryanjdavies.net

Sang Soo Kim

The Korea Development Bank ( email )

16-3, Yeouido-dong
Yeongdeungpo-gu
Seoul
Korea, Republic of (South Korea)
+822 787 7303 (Phone)
+822 787 7391 (Fax)

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