In order to reduce the risk resulting from spot price fluctuation by implementing hedging starategy, it is important to decide the appropriate hedge ratio. Until now, several conventional econometric models such as OLS model which is the simplest, VAR model which inconporates the past spot and futures prices, error correction model which comes from cointegration relationship between spot and futures prices have been suggested and used to estimate the hedge ratio for implementing hedging starategy.
This paper evaluates the hedging performance of various hedge ratios estimated from conventional econometricmodels and investigates the effects of incorporating the fractional cointegration relationship-error correction term is fractionally integrated-into futures hedging.
Findings of this paper are as follows. First, we finds the prevalence of fractional cointegration relationship between spot and futures prices. Second, the new model which incorporates the fractional cointegration improves the hedging performance over conventional models.
