Ex ante hedge ratios and the hedging effectiveness of the FTSE-100 stock index futures contract

Abstract

This paper examines the hedging effectiveness of the FTSE-100 stock index futures contract over the period 1984–92. Previous studies have examined this issue using ex post hedge ratios, resulting in an overestimation of hedging performance. This study utilizes ex ante hedge ratios which are determined on the basis of historical information. It is shown that while hedge ratios vary through time, nonetheless it is possible to use this futures contract to achieve very substantial risk reduction as compared to an unhedged position. Hedge ratios estimated over longer periods are shown to provide greater risk reduction when applied in subsequent periods.

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