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

Adrian Trapletti a.trapletti at swissonline.ch
Fri Aug 12 13:16:42 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

I guess your results are highly affected by spurious regression. You 
should work with stationary variables such as the % price change and 
include knowledge about the relationship between spot and futures markets.


Adrian Trapletti
Wildsbergstrasse 31
8610 Uster

Phone :   +41 (0) 44 9945630
Mobile :  +41 (0) 76 3705631

Email :   a.trapletti at swissonline.ch

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