We thank Henk Berkman, Audra Boone, Bob DeYoung, Jeff Mercer, Shane Moriarity, Panos Patatoukas, Peter Wells, Jide Wintoki, and seminar participants at the University of Kansas, University of Auckland, Massey University, the American Accounting Association Conference, the Financial Management Association Conference, and the Southern Finance Association Conference.
The Effect of the Hedge Horizon on Optimal Hedge Size and Effectiveness When Prices are Cointegrated
Article first published online: 16 SEP 2011
© 2011 Wiley Periodicals, Inc.
Journal of Futures Markets
Volume 32, Issue 9, pages 837–876, September 2012
How to Cite
Juhl, T., Kawaller, I. G. and Koch, P. D. (2012), The Effect of the Hedge Horizon on Optimal Hedge Size and Effectiveness When Prices are Cointegrated. J. Fut. Mark., 32: 837–876. doi: 10.1002/fut.20544
- Issue published online: 16 JUL 2012
- Article first published online: 16 SEP 2011
- Manuscript Accepted: 1 JUL 2011
- Manuscript Received: 3 FEB 2011
This study compares two alternative regression specifications for sizing hedge positions and measuring hedge effectiveness: a simple regression on price changes and an error correction model (ECM). We show that, when the prices of the hedged item and the hedging instrument are cointegrated, both specifications yield similar results which depend on the hedge horizon (i.e., the time frame for measuring price changes). In particular, the estimated hedge ratio and regression R2 will both be small when price changes are measured over short intervals, but as the hedge horizon is lengthened both measures will converge toward one. These results imply that, when prices are cointegrated, a longer hedge horizon will yield an optimal hedge ratio closer to one, while at the same time enhancing the ability to qualify for hedge accounting. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark 32:837–876, 2012