The Method And Empirical Analysis Of Hedging With Foreign Currency Denominated Stock Index Futures

That the stock index futures came into the world was called an innovation on stock trading. The trading on stock index futures received the recognition of the most stirring financial innovation. After twenty years' development, many countries in the world began to trade stock index futures step by step. Futures on stock index already became one of the most successful futures products.Emerging stock markets especially in some Far East economies have been experiencing fast-paced real and monetary growth and continue to attract attention of investors in developed countries who look for opportunity to enhance portfolio performance. However, such markets are noticeably volatile and unpredictable, exposing investors to substantial equity price risk in addition to exchange rate risk. Moreover, an active stock index futures market may not exist in most emerging economies, making foreign equity price risk manage more difficult. Recently, a class of innovative derivative instruments (such as MSCI Taiwan index) has been created to facilitate foreign equity price risk management especially for international investors.To hedge with foreign currency denominated stock index future, the interdependence of equity, futures, and foreign exchange markets is important in formulating hedging strategies. We derive and compare optimal hedging strategies for international and domestic investors.We make an empirical analysis on MSCI Taiwan index futures traded on the SGX , derive and compare optimal hedging strategies for both types of investors, and assess in-sample and out-of-sample hedging effectiveness of various hedging techniques, including a GARCH error-correction model, the ordinary least squares(OLS) hedge and a naive hedge. Our results indicate that: both types of investors gain from hedging with the MSCI Taiwan index futures, while international investors appear to benefit more than domestic investors; conditional hedging consistently outperforms other hedging strategies because the GARCH error-correction models utilize the most up-dated information when making hedging decisions.