An empirical analysis of the relationship between the hedge ratio and hedging horizon: A simultaneous estimation of the short- and long-run hedge ratios

Abstract

This article analyzes the effects of the length of hedging horizon on the optimal hedge ratio and hedging effectiveness using 9 different hedging horizons and 25 different commodities. We discuss the concept of short- and long-run hedge ratios and propose a technique to simultaneously estimate them. The empirical results indicate that the short-run hedge ratios are significantly less than 1 and increase with the length of hedging horizon. We also find that hedging effectiveness increases with the length of hedging horizon. However, the long-run hedge ratio is found to be close to the naive hedge ratio of unity. This implies that, if the hedging horizon is long, then the naive hedge ratio is close to the optimum hedge ratio. (C) 2004 Wiley Periodicals, Inc.