Hedging Effectiveness of Stock Index Futures Contracts in the Indian Derivative Markets

Abstract

This paper studies hedging effectiveness in Indian stock index futures market. The main focus is on various procedures to estimate time-varying and static optimal hedge ratios. For the S&P CNX Nifty futures contract 5 different econometric models that are employed. The data set used is from 2001-2008. Traditional OLS regressions, modified OLS viz. LTS , error correction model (ECM), vector error correction model (VECM) and multivariate generalized autoregressive heteroscedastic (M-GARCH) models are used to estimate hedge ratios, not only for mirror index underlying the futures contract but also for mutual funds. It is the first exhaustive study of its kind on the Indian stock index futures market and reveals that mutual funds tend to be a good proxy for market portfolios. Simple OLS seems to provide the best hedging effectiveness in terms of risk reduction for the Indian futures market. However, the use of more complex models like VECM cannot be sublimed as they provide more or less same hedging effectiveness. Keywords: Hedge ratios, OLS, VECM, M-GARCH, Nifty futures.

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