Cointegration, Price-Adjustment Delays, and Optimal Hedge Ratio in the Precious Metal Markets

Abstract

Firms seeking to apply hedge accounting treatment under the Accounting Standards Codification Topic 815 must demonstrate higher hedge effectiveness, for which the regression analysis is commonly used as a testing method. An autoregressive distributed lag (ARDL) model is adopted in this article to examine the hedge effectiveness in the presence of nonsynchronous trading of spot and futures contracts as well as a long-run cointegrating relationship between their prices. Using precious metal market data, our study empirically demonstrates that a hedge ratio estimated with a conventional OLS model tends to be downwardly biased. Our finding also indicates that the omitted-variable bias becomes apparent only when the difference between the transaction frequencies in spot and futures markets is significantly large.