An Empirical Analysis of the Hedging Effectiveness of Currency Futures
Posted: 13 Jul 1998
Date Written: December 1995
Existing research on the hedging effectiveness of currency futures assumes that futures positions are continuously adjusted. This is an unrealistic assumption in practice. In this paper we study the hedging effectiveness for futures positions which are not adjusted during the hedge period. For this purpose an out-of-sample approach is used. Three models are used to determine hedge ratios and hedging effectiveness. These are the minimum-variance model of Ederington (1979), the target return model of Fishburn (1977), which is a model in which the disutility of a loss is minimized, and the Sharpe-ratio model of Howard and D'Antonio (1984, 1987). For the minimum-variance model and the target return model it is found that the naively hedged positions yield a higher effectiveness than the unadjusted model-based hedged positions. For the Sharpe-ratio model it is found that both naively and model-based hedged positions lead to a lower hedging effectiveness than unhedged positions.
JEL Classification: G13
Suggested Citation: Suggested Citation