Carry Cost Rate Regimes and Futures Hedge Ratio Variation

This paper tests whether the traditional futures hedge ratio (h_T) and the carry cost rate futures hedge ratio (h_c) vary in accordance with the Sercu and Wu (2000) and Leistikow et al. (2019) “h_c” theory. It does so, both within and across high and low spot asset carry cost rate (c) regimes. The high and low c regimes are specified by asset across time and across currency denominations. The findings are consistent with the theory. Within and across c regimes, h_T is inefficient and h_c is biased. Across c regimes, h_c’s Bias Adjustment Multiplier (BAM) does not vary significantly. Even though h_c’s bias-adjusted variant’s BAM is restricted to old data that is from a different c regime, the hedging performance of h_c and its bias-adjusted variant (=h_c × BAM), are superior to that for h_T. Variation in c may account for the h_T variation noted in the literature and variation in c should be incorporated into ex ante hedge ratios.