Time-Varying Hedge Ratios: An Application to the Indian Stock Futures Market

Abstract

Using different unconditional and conditional versions of the bivariate BEKK-GARCH model of Engle and Kroner, we calculate time-varying hedge ratios for Indian stock futures market involving a cross-section of seven firms across a spectrum of industries. These models are solved not only with the usual square root exponent but also analysed with an unrestricted version where the exponent is set to one. Our results show time-varying hedge ratios with the exponent set to one improve over hedge ratios obtained from the square root exponent setup as well as over static hedge ratios calculated from the error correction types of models. Time-varying optimal hedge ratio calculation in this new framework makes perfect sense in terms of portfolio allocation decision involving individual stock futures.Unrestricted BEKK-GARCH, Stock Futures, Dynamic Hedging