Evaluating the effectiveness of futures hedging

Abstract

This chapter examines the Ederington hedging effectiveness (EHE) comparisons between unconditional OLS hedge strategy and other conditional hedge strategies. It is shown that OLS hedge strategy outperforms most of the optimal conditional hedge strategies when EHE is used as the hedging effectiveness criteria. Before concluding that OLS hedge is better than the others, however, we need to understand under what circumstances the result is derived. We explain why OLS is the best hedge strategy under EHE criteria in most cases and how most conditional hedge strategies are judged as inferior to OLS hedge strategy by an EHE comparison.