Realized hedge ratio: Predictability and hedging performance

• Published in: International review of financial analysis 2016-05, Vol.45, p.121-133
• Main Authors: Markopoulou, Chrysi E., Skintzi, Vasiliki D., Refenes, Apostolos-Paul N.
• Format: Article
• Language: English
• Subjects: Dynamic hedging; Econometrics; Forecasting; Hedging; Hedging effectiveness; Rates of return; Realized hedge ratio; Statistical methods; Studies; Transaction costs
• ISSN: 1057-5219; 1873-8079
• DOI: 10.1016/j.irfa.2016.03.005

This study explores the dynamic properties and predictability of the Realized Minimum Variance Hedge Ratio (RMVHR), constructed from five-minute spot and future returns of two stock indices and two exchange rates. A number of econometric models are employed to forecast directly the RMVHR and the out-of-sample performance is evaluated. Results from statistical measures suggest that the evolution of the realized hedge ratio series is predictable. In terms of risk reduction, we conclude that realized hedge ratio forecasts dominate conventional methods that use daily data while the benefit is pronounced when economic gains are considered. The superior performance of RMVHR methods holds across different asset classes but is more conspicuous in the case of stock indices. Finally, this study assesses the effect of sampling frequency and transaction costs. •The direct modeling of the realized hedge ratio based on intraday data is proposed.•The predictability of the realized hedge ratio is examined using various model specifications.•Results reveal predictable patterns in the evolution of the series.•The forecasts of realized hedge ratio improve hedging performance and economic gains.•The superior performance holds across different assets, sampling frequencies and transaction costs.