Better cross hedges with composite hedging? Hedging equity portfolios using financial and commodity futures

Chen, F. and Sutcliffe, C. (2012) Better cross hedges with composite hedging? Hedging equity portfolios using financial and commodity futures. European Journal of Finance, 18 (6). pp. 575-595. ISSN 1351-847X doi: 10.1080/1351847X.2011.620253 (In Press)

Abstract/Summary

Unless a direct hedge is available, cross hedging must be used. In such circumstances portfolio theory implies that a composite hedge (the use of two or more hedging instruments to hedge a single spot position) will be beneficial. The study and use of composite hedging has been neglected; possibly because it requires the estimation of two or more hedge ratios. This paper demonstrates a statistically significant increase in out-of-sample effectiveness from the composite hedging of the Amex Oil Index using S&P500 and New York Mercantile Exchange crude oil futures. This conclusion is robust to the technique used to estimate the hedge ratios, and to allowance for transactions costs, dividends and the maturity of the futures contracts.