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Hedging with Mispriced Futures

Published online by Cambridge University Press:  06 April 2009

John J. Merrick Jr
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Abstract

This paper analyzes the correspondence between arbitrage sector pricing efficiency and the short-term hedging costs and effectiveness of futures contracts. Reversals of initial contract mispricings by arbitrage sector trading leads to an important mispricing return component in the total return to hedge portfolios. The existence of the mispricing return has implications for initial hedge ratio selection, hedging effectiveness, and expected hedge return. The analysis is used to interpret the hedge ratio guidance and performance of short-term hedges between the Standard and Poor's 500 stock index futures contract and the underlying S&P 500 cash stock index portfolio over the 1982–1986 period.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 23 , Issue 4 , December 1988 , pp. 451 - 464
Copyright
Copyright © School of Business Administration, University of Washington 1988

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