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Optimal Hedging Ratios for Wheat and Barley at the LIFFE: A GARCH Approach
Author(s) -
Dawson P. J.,
Tiffin A. L.,
White B.
Publication year - 2000
Publication title -
journal of agricultural economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.157
H-Index - 61
eISSN - 1477-9552
pISSN - 0021-857X
DOI - 10.1111/j.1477-9552.2000.tb01220.x
Subject(s) - futures contract , autoregressive conditional heteroskedasticity , hedge , economics , autoregressive model , heteroscedasticity , econometrics , position (finance) , constant (computer programming) , futures market , spot contract , financial economics , mathematics , finance , volatility (finance) , computer science , ecology , biology , programming language
Over 100,000 futures contracts for cereals are traded annually on the London International Financial Futures Exchange. The proportion of the spot position held as futures contracts ‐ the hedging ratio ‐ is critical to traders and traditional estimates, using OLS, are constant over time. In this paper, we estimate time‐varying hedging ratios for wheat and barley contracts using a multivariate generalised autoregressive conditional heteroscedasticity (GARCH) model. Results indicate that GARCH hedging ratios do change through time. Moreover, risk using the GARCH hedge is reduced significantly by around 4 per cent for wheat and 2 per cent for barley relative to the no hedge position, and significantly by around 0.2 per cent relative to the constant hedge. The optimal, expected utility‐maximising, and the risk‐minimising hedging ratios are equivalent.