I wants to calculate Hedging Effectiveness (HE). The formula for HE is
HE= (Variance of un-hedge portfolio- variance of hedge portfolio)/Variance of un-hedge portfolio.
I am confused what is the value of un-hedge portfolio variance. If I use the variance of series from MV GARCH model then HE is very small.
My question is; to find the un-hedge variance I have to estimate the un-variate GARCH model or the squared of return of a series?
Please guide me
Irfan Awan
(Pakistan)
I assume that you have a time series of the values of the hedged and unhedged portfolios. If I were doing this project, I would use standard portfolio mathematics and write an Excel spreadsheet to do the calculations. You must remember that even in the best of circumstances GARCH models (unlike OLS models) are biased estimators. You clearly have some problem with the GARCH model if you are getting unrealistic results. The problem could be a shortage of observations, some mis-specification, etc.
Dear Jan,
Can you please share this Excel file with me
Regards, Irfan
Irfan,
Unfortunately, I no longer have the file. However, Bodie, Kane, and Marcus have an excellent discussion of portfolio mathematics. See "Investments", Third Edition, Bodie, Kane, and Marcus, pp. 150-155. Some useful formulas are given on the back inside cover.
Regards, Jan
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