The hedging effectiveness of currency futures

This project compares four different hedging techniques using spot and futures exchange rates of the British Pound. Specifically, the OLS regression model, the vector autoregressive model (VAR), the vector error correction model (VECM) and the Multivariate GARCH with error correction model are applied. Hedging effectiveness is measured in terms of minimizing variance of hedged portfolios. The VAR model and the VECM offer the same performance, which is higher than that of the OLS model. Although the multivariate GARCH with error correction model is the only one being able to capture the time varying nature of the hedge ratio, the hedging performances of four str ategies do not differ very much, either in-sample or out-of-sample. Therefore, although complex models are able to capture more figures of the data set, there is no evidence that they will give significant better hedging performance.