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Basis Convergence and Long Memory in Volatility When Dynamic Hedging with Futures

Published online by Cambridge University Press:  06 April 2009

Jonathan Dark
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Abstract

When market returns follow a long memory volatility process, standard approaches to estimating dynamic minimum variance hedge ratios (MVHRs) are misspecified. Simulation results and an application to the S&P 500 index document the magnitude of the misspecification that results from failure to account for basis convergence and long memory in volatility. These results have important implications for the estimation of MVHRs in the S&P 500 example and other markets as well.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 42 , Issue 4 , December 2007 , pp. 1021 - 1040
Copyright
Copyright © School of Business Administration, University of Washington 2007

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