Optimal Hedge Ratio and Hedge Effectiveness of Equity and Currency Futures Contracts: Evidence from NSE

Abstract

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The present study attempts to examine hedging effectiveness of equity and currency futures contracts traded at the National Stock Exchange of India, by taking a sample size of three benchmark indices of equity futures market (NIFTY50, NIFTYIT, and BANKNIFTY) and four currency futures contracts (USD, YEN, EURO, and GBP). For estimating optimal hedge ratios, five constant hedge ratio models and three time-varying hedge ratio models have been used. For estimating hedging effectiveness, two approaches have been used, i.e., variance reduction approach and risk-return approach. The findings of the study indicate that hedging effectiveness is higher in equity futures contracts (more than 96 per cent); in currency futures contracts, it is less than 40 per cent. Another significant finding is that constant hedge ratio models generate superior hedging effectiveness, irrespective of the approach used for estimating hedging effectiveness. Hence, the present study is also an addition to the existing literature that supports superiority of constant hedge ratios over time-varying hedge ratios.

Keywords: Hedge Effectiveness, GARCH, Constant Hedge Ratios, Currency Futures, Equity Futures

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