A Comparison of Measures of Hedging Effectiveness: A Case Study using the Australian All Ordinaries Share Price Index Futures Contract

Abstract

Several techniques to assess the effectiveness of a hedge have been suggested in the literature. While these techniques hold theoretical appeal, there is little empirical evidence as to their effectiveness. This paper provides an empirical comparison of three measures of hedge effectiveness in the context of hedging market risk using the Australian All Ordinaries Share Price Index Futures contract. Specifically, the Markowitz (1959) portfolio standard deviation measure, the Howard and D'Antonio (1987) <i>HBS</i> measure and the measure suggested by Lindahl (1991) are applied to assess hedge effectiveness. The results indicate that the selection of the particular measure of hedge effectiveness has a considerable impact on the assessment of hedged portfolios. Further, the paper highlights problems that arise in applications of the Lindahl (1991) and Howard and D'Antonio (1987) measures.