High Frequency Data and Optimal Hedge Ratios

Abstract

In this chapter, we look at the informational content of intraday data in order to optimise and reduce minimum variance hedge ratios. We define three hedge ratios, namely, two ratios calculated from daily data and a third one based on intraday data. Borrowing from the calculation of minimum variance hedge ratios, we estimate half-hourly minimum variance hedge ratios (the ratio of one contract to another, which provides the minimum variance) in order to check whether there is any value-added in estimating such ratios based on intraday data. The empirical application concerns two government bond futures contracts and their respective 3-month interest rate futures contracts traded on LIFFE. The data period covers three years of observations, January 1994-December 1996, sampled at half-hourly intervals. Evidence tends to indicate that ratios calculated from intraday data exhibit a substantially lower variance compared to the other two hedge ratio specifications. Furthermore, a cash flow analysis shows that the use of such intraday-based ratios might help reduce the maximum potential loss incurred whilst holding a spread position.