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Model Specification for the Estimation of the Optimal Hedge Ratio with Stock Index Futures: an Application to the Italian Deri

Several techniques to estimate the hedge ratio with index futures contracts have been proposed in the literature. While these techniques hold theoretical appeal, there is no univocal evidence as to their effectiveness. This research provides an empirical comparison of four different econometric techniques in the context of hedging the market risk using the FIB 30 index futures contract of the Italian Derivatives Market. Specifically, the OLS regression model, the bivariate vector autoregressive model (BVAR), the vector error correction model (VECM) and the multivariate GARCH model are employed. Then the hedging effectiveness is measured in terms of ex-post and ex-ante variance minimization. It is generally found that only the GARCH model is able to outperform the OLS model and the improvement is not really consistent.