Minimum Variance Hedging and Stock Index Market Efficiency

This empirical study examines the impact of both advanced electronic trading platforms and index exchange traded funds (ETFs) on the minimum variance hedging of stock indices with futures. Our findings show that minimum variance hedging may provide an out-of-sample hedging performance that is superior to that of the one-one futures hedge, but only in markets without active trading of ETFs and advanced development of electronic communications networks. However there is no evidence to suggest that complex econometric models that include, for instance, time varying conditional covariances and error correction can improve on the simple ordinary least squares hedge ratio. Furthermore, in markets with actively traded index ETFs and where electronic trading has become established, no significant efficiency gains are apparent from any minimum variance hedge.