[R-sig-finance] help on optimal hedge variance ratio required

Krishna snvk4u at gmail.com
Fri Aug 12 11:41:58 CEST 2005

Hi everyone

I am trying to estimate the optimal hedge variance ratio for cross
hedging two commodities. the price levels are used (compared to price
change and % price change) and used the OLS with dummy variable for
estimating the co-efficients. the equation looks like this

Y = B + B1*D1 + B2*X + B3*(X*D1)

Where Y = Daily Cash market price
D1 = Dummy variable taking value 1 for period Oct-Mar and 0 for Apr-Sep
X = Daily futures market price on which cross hedging is done.
B,B1,B2,B3 are the slope co-efficients.

The results look like this
Regression Statistics
Multiple R              0.948702709
R Square                0.900036831
Adjusted R Square       0.89981135
Standard Error          25.52050965
Observations            1334

      Coefficients    Standard Error  t Stat  P-value
Intercept       53.817          4.375           12.300  0.000
X       0.986           0.012           80.283  0.000
D1      27.399          6.106           4.487   0.000
D1 * X  -0.100          0.017           -5.820  0.000

It is understood the slope co-efficients for different periods are
significant as indicated by t-table value. But I feel suspicious on
the reliability of this values.

I have used 5 years of daily price data for running the regression,
and I feel suscpicious becasue, the monthly correlations (pearson
correlation co-efficient) are highly varying between spot and futures
and some times even negative.

Can someone suggest me
a) the tests to judge the reliability of hedge-variance values
b) Is there any other better method than described here for estimating
the hedge-variance values

Thank you for the attention and look forward for an early reply



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