Cross Hedging Effectiveness of S&P500 and NIKKEI225 Futures to the Philippine Stock Exchange Composite Index

Abstract

The study evaluated other countries’ index futures in managing risk of PSEi by using 486 daily closing prices from, May 15, 2013 to October 8, 2015. Cross-hedging ratios and cross-hedging performance of S&P500 and NIKKEI225 futures were estimated with the use of the OLS regression, VECM and the GARCH models. The cross-hedging effectiveness analysis was performed by in-sample and out-of-sample excluding data of 86 days. The results from unit root test showed that the time series of the first difference variables were stationary. The long-run relationship between PSEi and the three index futures was established by applying the Johansen co-integration model. The computed hedge ratios and cross-hedging effectiveness were almost similar for OLS and GARCH method. Among the two index futures, S&P500 futures has better cross-hedging effectiveness with PSEi than NIKKEI225 futures. But overall, the two futures used was not as effective in minimizing risk of PSEi as compared to direct hedging. Hence, it is necessary to look for other possible risk management tool (i.e. other countries’ index futures/foreign exchange futures) to be cross-hedged with PSEi that will produce a better hedging effectiveness.